The currency wars being waged among the world’s nations at this time are going to continue for quite some time, according to Jim Rickards, author of Currency Wars. In this DJ FX Trader podcast posted at the Wall Street Journal, Rickards explains how nations around the world will likely continue their currency devaluations in order to gain an edge in their international trading.
After all is said and done, this is basically what’s been happening in Europe, where countries like Spain, Greece, Ireland, Portugal, Italy and Cyprus depend on each other and the stronger members of the European Union to keep buying their bonds, burying them ever deeper in debt (to each other).
But it’s not limited to just Europe, of course. The US is in just as bad of shape as far as debt is concerned. In all western nations, as the cartoon above adequately portrays, there seems to be a symbiotic relationship between the banks and the countries in debt. The banks enable the governments to keep borrowing just to be able to buy more debt from other countries’ governments, which are doing the exact same thing. The whole sovereign bond market is one giant Ponzi scheme, just waiting to capsize.
There’s been much discussion on the Fed’s newest monetary easing policy. The markets received their much anticipated stimulus and are reacting positively (for now). But as previous posts have indicated, the Fed’s stated objectives and motives are questionable at best. For a few steps further down the rabbit hole, here’s a must-see video from CrisisHQ.
“If you want to understand what’s happening in the Mideast, particularly in Libya, Syria and Iran, you must first understand the main driving force behind U.S. foreign policy. Contrary to mainstream media propaganda, it is not our desire to spread democracy or to prevent tyrannical despots from murdering their own citizens. The real agenda is to protect the Petrodollar system, because it is the only thing that is currently preventing the total collapse of our fiat currency.”
For more information on the Petro-Dollar, please see our research article: Root Cause: The Petro Dollar.
April 4, 2012
There’s a popular theory among the world population that the U.S. launched wars in the middle east in order to control its oil reserves. On the surface, this seems entirely logical, but the truth of the matter may be much more sinister, and one should look a little deeper into the situation. It’s not the oil reserves the U.S. is after, although oil does play its part in this charade. The main concern of the U.S. in these wars is more likely the maintenance of its hegemony with U.S dollar as the world’s reserve currency.
The U.S. dollar became the de facto world reserve currency after World War II, when delegates from around the world met and together agreed to what became known as the Bretton Woods System. Under this system, the U.S. dollar would be linked to gold at $35/ounce. All other nations would tie their currencies not directly to gold, but indirectly through the U.S. dollar. This meant that those nations would hold dollars in their foreign reserves to support their local currencies. In order to obtain dollars, those countries had to either borrow them from the U.S. Federal Reserve or earn them with a trade surplus. The U.S. got a sweet deal here – perhaps justified due to the fact that after the war the U.S. was indeed the strongest, most productive nation on the planet, along with a huge stash of physical gold.
This system worked well for the world and especially for the U.S. during the prosperous years of the 1950’s and 60’s. But with the U.S. printing its own dollars to cover its increasing debts, including the vast expeditures on the Vietnam War, the world became concerned. Suspicious that the U.S. gold reserves would not cover the existing issue of paper dollars, countries began to trade in their reserve dollars for gold at the U.S. treasury using the pegged value of $35/ounce. The U.S. gold stash was steadily declining.
In order to prevent the total depletion of U.S. gold supplies, in 1971 the Nixon administration closed the gold window – nations were no longer allowed to exchange their reserve dollars for gold. It was the end of the Bretton Woods System, but not quite the end of the U.S. dollar hegemony in world reserve currency status.
One must then ask the obvious question: Why would a nation now hold a seemingly valueless paper dollar as a reserve currency, especially since its tie to gold has been cut?
The answer: The Petro Dollar.
After Nixon closed the gold exchange window, the dollar was a free floating fiat currency, competing with other currencies around the globe. Inflation started to escalate since there was no tie to gold anymore. In fact, in 1975 the average price of gold was $160 – more than 350% increase in just 4 years since abandoning the gold window. Additionally, OPEC nations had been using the dominant dollar as a preferred payment method for their oil exports, but now they were starting to lose money as the dollar lost its value. In 1973, OPEC launched an oil embargo, raised prices and started internal discussions on the logistics for trading oil for other currencies including gold. Steps had to be taken by the U.S. if it was to re-secure the dollar as the strong world reserve currency.
The first step was taken in 1974 when Secretary of State Henry Kissinger launched the U.S.-Saudi Arabian Joint Commission on Economic Cooperation. Kissinger used the term “petrodollar recycling” to refer to the overall plan, which was to allow Saudi Arabia to purchase U.S. assets and services with the dollars it was receiving for its oil sales. A beneficial result for the U.S. was that the Saudi Arabian central bank (SAMA) could now use its dollar proceeds to buy U.S. debt (Treasury bills, bonds, etc.).
But the most beneficial outcome for the U.S. was that Saudi Arabia, the most dominant member of OPEC, would agree to continue to accept only U.S. dollars in exchange for its oil sales and would convince the other members of the cartel to do the same. By 1975, all OPEC member nations restricted their oil trade to dollar transactions. To this day, as long as these key oil states play along, their leaders are showered in luxury and are quite secure in that they’re guaranteed the defense by the U.S. military and its industrial complex.
Meanwhile, countries around the globe must accumulate dollars in their own foreign reserves in order to import the most vital energy component – oil. Nations have to aquire those dollars the hard way – by borrowing from the U.S. Federal Reserve or earning them by trading resources, goods and services to other nations for dollars. But the U.S. enjoys the outrageous advantage of being able to print as much of the world’s reserve currency as it wants. Not only has it been able to use these dollars to purchase its own oil on the cheap, it has been able to continually out-do itself in annual deficit spending, now in the trillions of dollars, because it has had captive buyers for its debt.
One would think someone would cry “Foul!” Well, someone did. The first nation to step away from this rigged system was Iraq. In November of the year 2000, Saddam Hussein declared that Iraq would no longer accept the dollar for trade in the Oil for Food program. Instead, the oil would be priced in and exchanged for Euros. Many said this would be a bad investment for Iraq at the time, but the move was actually beneficial because the dollar declined 17% against the Euro until the U.S. attacked and accomplished its mission in May of 2003. Of course, now that the country was “stabilized” the Iraqi oil trade was repriced in the dollar market again and things went back to “normal” for a while.
The system would be challenged a second time, this time by Libya. In February of 2009, Muammar Gaddafi was elected the chairman of the African Union and would continue the effort to create the United States of Africa, which among other things, would include a unified currency, a dinar based on gold. Gaddafi went so far as to suggest that the African nations’ oil trade would be switched from the dollar to this new gold currency. Here’s a segment from Russia Today:
Furthermore, it’s quite interesting to note that prior to the Libyan Revolution in February of 2011, Libya didn’t have a central bank linked with its western counterparts. It’s strange that before the “rebels” even had concluded battle, before they had even established a new government, they created a central bank.
And now the petro dollar has a third challenger – Iran.
The western powers are terribly concerned with Iran’s pursuit of nuclear technology. Mahmoud Ahmadinejad has publicly stated his intent to “destroy Israel” and of course this is not something to be taken lightly. Additionally, one must wonder why Iran would even need nuclear power when they’re sitting on one of the world’s largest oil and natural gas deposits.
However, attention should be given to recent events. Early in 2008, Iran launched a new commodity exchange known as the Iranian Oil Bourse. The intent was to allow for Iranian oil to be priced and traded with multiple currencies. As the system was ramped up, initially the exchange limited its trade to secondary petroleum products, with crude oil to be added “when the system was ready.” Iran recently announced it would be ready on March 20, 2012. This was a declaration of war on the petro dollar!
The U.S. along with the EU then implemented a defense. Just prior to the expansion of the Iranian exchange, on March 17, the EU carried out orders to expand sanctions against Iran by removing Iranian banks from the international bank-wire transfer system known as SWIFT. Furthermore, any banks caught doing business with Iran would be sanctioned as well. It seems Iran’s entire international commerce engine has been halted and its oil industry crushed.
Japan, China, India and Turkey are among the countries who’ve been dependent on Iranian oil to some degree. Various discussions have been taking place between Iran and its trading partners on the possibility to enlist trade for other commodities such as gold or grain. Unless someone caves in here, another war – perhaps a big one – seems to be on the horizon.
If you want to understand what’s happening in the Mideast, particularly in Libya, Syria and Iran, you must first understand the main driving force behind U.S. foreign policy. Contrary to mainstream media propaganda, it is not our desire to spread democracy or to prevent tyrannical despots from murdering their own citizens. The real agenda is to protect the Petrodollar system, because it is the only thing that is currently preventing the total collapse of our fiat currency.
Source material from books (available at Amazon) on the petro dollar:
A Century of War: Anglo-American Oil Politics and the New World Order – 2004, F. William Engdahl
The Hidden Hand of American Hegemony: Petrodollar Recycling & International Markets – 1999, David E. Spiro
- Confessions of an Economic Hit Man – 2004, John Perkins
Here are links to further reading on OPEC’s petro dollar recycling:
That’s what the ‘powers that be’ are saying as increasing numbers of people are seeing the truth behind the wickedness of our central banking system!
“It is well that the people of the nation do not understand our banking and monetary system. For if they did, I believe there would be a revolution before tomorrow morning.”
– Henry Ford
A Discourse on the Federal Reserve System
October 25, 2011
Many politicians and economists always talk about ridding America of its debt. But the truth is, the system depends on debt to sustain itself. There wouldn’t be any currency for people to spend unless there was debt that inspired the creation of it in the first place. If the debt is reduced, there will be a corresponding reduction in the currency supply. And if the debt is erased completely, there wouldn’t be any currency at all. It’s amazing, but true – the system traps its users in a perpetual debt cycle. It’s a scam of epic proportions and only a tiny percentage of the population have grasped the significance of what that means.
Every dollar represents no more than simple debt. A dollar is an IOU from the Federal Reserve. That’s why every bill actually says “Federal Reserve Note” – a piece of paper which represents a promise by the Federal Reserve to pay you a quantity of dollars. It’s not a promise to pay in gold, silver or anything else of any value. It only promises the reimbursement of dollars. The obvious question, then, is why would someone turn in such a note in order to receive back exactly the same note? It’s a good question, but most people don’t know enough about the currency system in order to pose that question.
The following is an explanation of the way the Federal Reserve System works in the United States. It’s a crazy system indeed. For verification of these facts and a history of central banking in America, the reader is urged to read G. Edward Griffin’s book, The Creature from Jekyll Island.
1. U.S. Treasury creates Bills, Notes & Bonds
The United States Government needs money to operate. So, the U.S. Treasury sells Bills, Bonds & Notes. All of these are debt instruments which promise to pay back to the buyer the original purchase price, plus interest, at some time in the future.
2. Federal Reserve buys the U.S. Treasury Debt
Certain banks, known as Primary Dealers, buy the U.S. Treasury’s debt instruments during Treasury auctions. But these Primary Dealers are really only “middle-men” because through Open Market Operations (OMO), the Federal Reserve ends up holding the Treasury’s debt and writes a Federal Reserve Check to cover the cost.
But here’s the important thing to remember – the Federal Reserve doesn’t have any money to cover this check. The check represents money created out of thin air!!! This is what prompted Griffin to refer to this system as the “Mandrake Mechanism,” referring to a magician of the early 1900’s who was famous for making things appear from nothing.
3. Federal Government gets the Cash & Spends
The Federal Reserve’s check is credited toward the Federal Government in a Federal Reserve Bank account. From this account, the Federal Government is able to disburse funds as necessary among the various branches of government in order to pay for all the deficit spending, welfare programs and wars.
4. People & Contractors get the Cash & Make Deposits
Government employees and soldiers in the military receive their paychecks. Contractors get paid for their crony-acquired government projects. The employees, soldiers and contractors then make deposits into their personal bank accounts across the nation. Now the currency creation starts to happen in the commercial banks.
5. Banks Take Deposits & Practice Fractional Reserve Banking
Once the commercial banks get these deposits from their customers, they employ Fractional Reserve Banking to create yet more currency into existence. In Fractional Reserve Banking, the banks are able make loans to other people in amounts much greater than the sum they actually have in their reserves. For example, if a bank gets a deposit of $1000 from someone, it only needs to keep $100 for its reserve base. The bank is therefore able to multiply that original deposit by 90% and make a new loan to someone else for $900 (90% more currency created out of thin air). The bank now has reserve assets made up of the $100 from the original deposit plus a $900 loan that generates monthly income from the new borrower. But the original depositor still has a claim on the entire $1000.
6. New Loans are Re-Deposited
All the people receiving these new loans take the money and re-deposit it into their banks. And again, those banks take the deposits and turn them into even more currency by re-employing the fractional reserve banking concept and loaning out more to others. Following the example used above, the new $900 deposit becomes a source for a new loan by taking 90% of that – a new loan of $810 for someone, generating yet another blast of currency out of thin air.
The above steps are repeated over and over again. Repetitive iterations of steps 5 & 6 produce slightly less currency in the system than the previous iteration, but in the end, the commercial banking system has been able to create almost 10 times the amount of currency that was created by the Federal Reserve in the first place.
The really interesting point here is not the mere currency creation out of thin air, because many people are already familiar with the printing press concept. What’s really amazing is that all this currency creation cannot happen unless someone borrows it into existence. Our government takes the original loan from the Fed in the first step. All subsequent steps depend on the public to take on debt. It’s truly a perpetual debt system.
Here’s Mike Maloney explaining all this at the Casey Summit, When Money Dies…
There are two more ways which the Fed creates debt currency, which are just additional ways of creating money out of thin air. These are the following:
- The Discount Window. The Federal Reserve uses the Discount Window to allow banks to borrow money to increase their own base supply. Sometimes banks run short of money because they experience temporary surges in customer withdrawals. Additionallly, bad loans become problematic for the bank – the underlying assets sometimes need to be written off. In these cases, the bank’s currency reserve is reduced, placing in jeopardy their ability to maintain their miminum fractional reserve base.
The Federal Reserve is the “banker’s bank.” The Discount Window allows the banks to increase their currency reserve by simply taking a loan from the Fed. But remember, the Fed doesn’t have any money, so this is just more currency creation out of nothing!
- Reserve Ratios. In the examples above and in Mike Maloney’s discussion, a reserve ratio of 10 to 1 (or 90%) was used as the fractional reserve base. But the Fed can alter this ratio specification at any time depending on what it deems necessary. Essentially, this allows them to increase or decrease the rate at which the currency supply grows at any time by simply re-defining the rules for banks keeping a certain percentage of reserves in relation to their loans.
So the Federal Reserve System is quite a remarkable thing indeed. One wonders how long it will be before the populous wakes up to the scam!
Here are a couple of videos discussing the Federal Reserve and central banking concepts.
What’s causing the Rise in Gold & Silver?
March 12, 2011
Precious metals such as gold and silver have been on the move lately. The one-word answer as to why this is happening is “inflation.” But that could be said about all commodities like oil and food, which are also going up in price. To fully comprehend why the precious metals are soaring, we need to understand the following:
- What is money?
- Why have people around the world respected
the US dollar?
- What has the US Federal Reserve been doing
to destroy the value of the dollar?
- What has the US government been doing to
destroy the value of the dollar?
- What has the US consumer been doing to aid
in the destruction of the dollar?
- What is the magnitude of the US dollar’s
- Are other currencies around the world having
- Has this all happened before in human history?
Once we understand all these things, it will be easy to answer the ultimate question:
- Why do gold and silver preserve wealth and thus make for a sound investment in these times of crisis?
By reviewing these questions we hope to attain speculative intelligence and investment insight. We hope to understand why precious metals such as gold and silver provide financial protection in these economic times of turmoil. So let’s tackle each of these items one by one….
Understanding the concept of ‘Money’
It may seem like common sense, but it is worth asking yourself about the concept of ‘money.’ For example, why is it that people readily take the dollar in exchange for goods and services? What is it about the dollar bill that makes it have value in this manner? After all, it’s just a piece of paper, right?
Yes, money makes the world go around, as the saying goes. It provides an easy mechanism by which goods and services can be exchanged, without resorting to a cumbersome barter system of direct trade. If a carpenter wants a chicken for dinner, he doesn’t have to wait until the farmer needs a new barn built – he can use money.
But we still have not answered the question. What gives money its value? Today, in America, this is a question which has an answer that is different from what the answer would have been 100 years ago. Back then, there was something behind the American dollar that gave it value. Each dollar represented 1/20 of an ounce of gold. If desired, a person could even receive bullion by trading in their paper dollars – gold certificates could be exchanged for gold and silver certificates for silver.
But as we shall see, this is not the case today. The only thing that gives value to the US dollar today is the faith that people have in the US government and its financial institutions. What kinds of things might cause that faith to fade and what would be the consequences?
The Mighty US Dollar
The US dollar was not always recognized as a global power currency. Prior to World War II, Great Britain had enjoyed having the world’s strongest currency – the pound sterling. But in 1931, Britain had to begin devaluing its currency in order to pay for debts accumulated fighting and financing war with Germany. After World War II, the US dollar became the world’s leading currency and as we shall see, the US is now coincidentally undertaking similar devaluation strategies because of its debt.
Many people talk about how bad the Great Depression was, which started with the stock market crash of 1929. As part of the effort to bring financial strength back to the American economy, in 1933 Franklin D. Roosevelt confiscated almost every ounce of gold bullion from U.S. citizens, paying them $20.67/ounce. After all the gold was acquired, the government revalued gold at $35/ounce, thus immediately solving the impending national monetary crisis – the U.S. government simply inflated its way out of the problem because they could now print more money to represent the gold in their vaults. But worse, gold redemption and bullion ownership by the private American citizen was outlawed. (The only way to legally own more than $100 of gold was in the form of rare coins and jewelry that were said to be worth more than the gold itself. It wasn’t until 1974, when President Ford signed a bill that made ownership of gold as a commodity legal again.)
In 1937 this confiscated gold was placed into a new bullion depository at Fort Knox. The gold was immediately used to stabilize the U.S. dollar against foreign currencies – funding the Exchange Stabilization Fund (ESF), a tool used by the treasury to ‘control’ the value of the dollar in relation to foreign currencies. Essentially, this means that as foreign countries acquired U.S. dollars by selling their products to the American consumer, those foreign nationals were able to redeem those dollars and receive gold back from the US Treasury’s ESF. (Even though, strange as it may seem, it was still illegal for the U.S. citizen to exchange his paper money for gold from his own government.)
In 1945, after the war, the allied nations got together and instituted a foreign exchange policy, mandating that each member country tie their respective currencies to the US dollar, while the dollar would be directly tied to the price of gold. This was made possible, not just because the US was victorious in the war, but because prior to US involvement, through international trade with the European war parties, the US had accumulated most of the world’s gold reserves. This policy agreement is known as Bretton Woods. The policy allowed the US dollar to become the world’s preferred trading currency – because it was pegged at $35 per ounce of gold, it inspired confidence among foreign nations. In fact, oil and other commodities were denominated in US dollars and transactions between other nations occurred in dollars, rather than either of their own respective currencies. This resulted in a steady increase of US dollars being held in foreign countries’ national reserves and thus began the steady recognition of the mighty US dollar around the world.
This situation would last until 1971, when the U.S. had reached a critical point in its accumulation of debt. In addition to the U.S military activity in Vietnam, it had developed a trend of buying more stuff from foreign countries than it sells. This meant that foreign countries were acquiring more U.S. dollars at a faster pace. So, as foreign nations began to recognize that the U.S. may not be able to make good on its dollar promises, the U.S. gold supply was threatened to be over-run. This is why, in 1971, Nixon stopped all convertibility and prohibited the foreign exchange of U.S. dollars for gold, thus killing any remnant that was left of a gold standard for the US dollar. And as for Bretton Woods – it’s also dead. Member countries now need to be content holding U.S. paper in their reserves in lieu of any gold promises. And worse, the US Federal Reserve is now free to print as many dollars as it sees necessary because there isn’t any tie between the US dollar and any amount of gold or silver.
This left foreign countries little choice in what to do with the US dollars they were accumulating in their reserves. The only constructive thing they could do was to buy US Treasury bonds – America’s debt. The US pays interest to foreign countries owning these bonds, which, as we will see, is becoming an unbearable problem.
Federal Reserve (Fed) – Easy money policies
The concept of having an American centralized banking system has been the subject of many heated debates among many of America’s forefathers. Whether or not the institution serves us well could be the subject of an entirely different discussion, yet today we have the Federal Reserve (Fed).
The Fed has been busy recently – very busy. The following chart is from the Federal Reserve Bank of St. Louis. (Note that since this article was first published in March of 2011, the money creation has marched even higher.)
This chart illustrates how much money the Fed has been creating since inception. Instituted in 1913, the Fed’s monetary creation remained relatively mild up until Nixon removed the last remaining thread of the gold standard in 1971. At this point, since there doesn’t have to be any gold backing the paper currency, there is nothing to stop the Fed from printing as much money as it needs for anything it desires. On the chart, one can also easily pick out the relatively tiny blip from the 9/11 disaster. But the thing that should really grab your attention is the unprecedented money creation that started with the ‘crisis’ of 2008! This monetary build-up has dwarfed everything up to that point.
So what caused this sudden spike in money creation?
If you recall, back in 2008, the US Treasury, Federal Reserve and leaders of about 10 of the biggest banking institutions had secret ’emergency’ meetings and pledged what they then said was $700 billion to stave off disastrous peril of our banking system. Turns out more than $3 trillion was actually thrown at the situation (and we aren’t even close to having solved any of the problems). Here are some of the articles that give more information about these bail-outs: Bloomberg, Washington Post and the Wall Street Journal.
Reading those articles, one can see at least two things that may be a bit surprising. First, the institutions getting emergency aid were not limited to the U.S. – there were plenty of foreign banks and institutions getting money from the Fed. Second, it wasn’t limited to banks, but included some large companies too, like General Electric and Harley Davidson. Apparently, US leadership bought into the idea that letting Harley Davidson Motorcycles go bankrupt would contribute to a disastrous peril of our banking system.
While it is true that many of the firms have now paid back the initial bailout funds, it should be noted that the Fed did not fully disclose all the information necessary to gain a complete picture of what happened. They did not indicate what each institution was putting up as collateral for this easy, low/no-interest money. This is probably because it was either toxic or non-existent. And all of that crap is still out there on the books, even though, according to those accounting rules instituted in early 2009, the books do not have to reveal the current market value (=0), but can mark them as what they would be worth if there were buyers and the economy was in good shape. If the truth were known, we’d have a full-on panic right now.
This leads us to the Quantitative Easing strategy the Fed has been employing.
QE-1) Soon after those bail-outs, from the end of 2008 to the beginning of 2010, the Fed purchased Treasuries and mortgage-backed securities to prop up Fannie Mae and Freddie Mac to the tune of approximately $1.5 trillion.
QE-2) On December 5th, in a 60 Minutes interview, Fed Chairman, Ben Bernanke said that he will keep printing money as he currently sees no other way out of this ‘economic slow-down.’ QE-2 is now underway, and if you think it will be limited to the $600 billion figure he’s mentioned, think again….. it will end up being much more! Here’s the 60 Minutes interview in case you missed it: Part 1 & Extended 2. He discusses deflation as being a real risk, which is heavily misleading. The Fed officially uses flawed techniques and data for measuring inflation (on purpose, of course), and deflation is actually a great thing for people who save their money. But the banks end up the losers in a deflationary economy and since the members of the ‘inner circle elite’ own all the banks, Bernanke will strive to protect them. In order to protect against deflation, the Fed is going to step in and buy U.S. Treasury bonds to the tune of $600 billion in the next 6 months, and probably continue afterwards. This, the Fed hopes, will keep interest rates down because as fewer foreigners are showing up to buy our ridiculous debt at these Treasury auctions, someone else has to step in and buy in order to keep those interest rates from climbing. (China, for example is becoming less willing to accept such low interest on US bonds, especially at such high risk due to the growing level of un-payable US debt.) Interestingly, this intended strategy has back-fired as interest on these bonds have been rising recently, indicating more problems ahead.
(By the way, if you like Jon Stewart, his take on this matter is highly entertaining – probably more so if you’re already somewhat hedged with your share of gold or silver.)
QE-3) We should expect to see at some point in the future a state and municipal bail-out package from the Fed. American cities and states are in a similar situation as that of the European community and will need to be bailed out soon.
QE-4) It is likely that the real-estate collapse will continue, so we might expect to see a bail-out specifically to prevent the banks from taking huge losses on un-sellable properties they’ve taken over. Once the ‘paper-work’ issues of the foreclosure crisis gets cleaned up, property seizures will most likely resume its rapid pace.
Concluding from all of this, the chart above has not yet finished it’s upward spike because, as already noted above, Bernanke is at this moment cranking up the printing presses again with QE-2 and will probably continue well beyond that point with QE-3, 4, …., n.
Most of the public hears these huge amounts of trillions of dollars and doesn’t even realize what is being discussed. But this page gives a nice representation of what a trillion dollars would look like if you were to have the physical cash stacked up in a huge warehouse somewhere. Yet the Fed acts as if all this cash is simply Monopoly money by its seemingly unending printing activities.
US Government – Deficit spending
After reviewing the Fed, some may wonder why we are now having a separate discussion on the government, as it may seem somewhat redundant. But contrary to popular belief, the Fed is not controlled by the US government. Rather, it’s an independent institution within the government. The Quantitative Easing strategies discussed above are separate from stimulus actions launched by congress.
How, in the name of God, did we allow our national debt to get to this ridiculous level? To understand what led us to this debt burden, we’ll now look at the wonderful world of politics and how it generates a perpetual cycle of government spending more than it receives in tax revenues.
Politicians rely on democracy to attain and retain their jobs. That is, to get elected, they must get the votes. To get the votes, they make promises. Candidates have been notorious for making promises to benefit a certain demographic or a certain group or organization.
In order to get elected, candidates avoid the difficult questions like those put to them about the fate of Social Security or Medicare, which face revenue declines and beneficiary recipient increases. They know that the demographic relying on continued benefits from these programs do not want to hear that those life-lines may be cut. So, they remain silent.
To make matters even worse, some organizations sponsor certain candidates by donating money to their election campaign funds. And in early 2010, there was new legislation passed that allows unlimited funding in this manner. In turn, this sometimes makes the elected officials somewhat beholden to those organizations and they are easily swayed by lobbyists – another tool used by organizations to subvert US lawmaking.
The result of all these kinds of politics is that candidates do not think long-term. They only concentrate on what will keep them in office in the near term. They avoid discussing the real cuts that are necessary to reduce the deficits, because they would be too painful for many citizens, which in turn, would not be good for their political careers. So they spend money the government doesn’t really have in order to satisfy the voters – they borrow from the future, believing that by the time the debt comes due, either it will be someone else’s problem or there will be some other distraction to avoid attention and extend debts even further.
To understand this political impact on the US national debt, let’s examine some of the recent programs and stimulus packages that have been launched by the US government.
Emergency Economic Stabilization Act of 2008: Under President George W. Bush near the end of 2008, this was a $700 billion dollar package initiated in response to the subprime mortgage crisis that threatened to bring down the banking system, as already described above, under the Fed’s action to bail-out the financial sector. (Included in this action was the Troubled Asset Relief Program – TARP – which was set up to take toxic assets off the banks’ books.)
American Recovery and Reinvestment Act of 2009: Under President Barak Obama in early 2009, this was a package of nearly $800 billion to stimulate the economy. The US consumer was tempted by ‘cash for clunkers’ (=$3 billion) and home buyers tax credits (=$22 billion). Jobless benefits were also extended due to the seemingly never-ending unemployment outlook (=$319 billion).
Patient Protection and Affordable Care Act: With a democratically-dominated congress, this health care reform bill was passed and signed into law by President Obama at the end of March, 2010. The package has been estimated to be a cost of $1 trillion over the next 10 years. It is still unclear where this money will come from because there are still legal battles being fought over the finer points of the measure.
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010: Again under President Obama, this package extends the tax cuts initiated under President Bush and has an estimated price tag of $858 billion. Tax cuts are usually welcomed by citizens, but can we afford it?
Here’s a neat page that shows the US national debt in real-time. As you can see it is now over $14 trillion. [Note: Written in 2011] But as the page also shows, that’s only our so-called discretionary spending. If you were to include unfunded, mandatory spending (interest payments on the existing debt, Social Security, Medicare, state and municipal debt, etc.) the US national debt has a number closer to $50 trillion! This is a deep hole to dig ourselves out of, considering the annual budget projections for 2011:
It’s getting a bit absurd, isn’t it? The US is already slated to spend $1.2 trillion more than it has for 2011 on top of an existing published debt of nearly $14 trillion. Until the politicians are willing to face this reality and stop acting solely on their own concern for future votes to remain in office, they will never be able to make the difficult decisions to reduce the deficit enough to pay down this debt. Tax cuts and welfare benefits are nice, but if drastic spending cuts are not made, the only way to pay for these nice things is to debase the dollar further by printing more money.
American Consumers Increased their Personal Debt
The economies of the world have been increasing their dependence on debt. As we have seen, the US has been leading the way. The policies employed by the US Fed, keeping interest rates at record lows, and the government, passing stimulus packages, have been relying on the consumer to keep the economy running by spending their money – money they don’t really have – on new cars, new houses, new appliances, etc. They are hoping that this spending will counteract the recent downturn in the economy. But most consumers are either waking up to the fact that they are already stretched too thin or the banks have become more restrictive in their lending due to their own balance-sheet problems.
Since the turn of the century, the Fed’s policies have made the acquisition of credit extremely easy, which meant more people could buy expensive homes at inflated prices. It wasn’t until the sub-prime mortgage crisis started to hit in 2007 that people started to realize that the large increases in home values were basically an illusion. Real-estate prices had been going higher simply because the banks were willing to lend ever increasing sums of money to people, many of whom had questionable credit worthiness. At some point, this so-called housing bubble had to burst, which it has and will probably take a while to correct.
As a result of this mess, more consumers are finding that they are too far in debt and struggling with their finances. The chart below is from NPR. Immediately below is the historical household debt for the US consumer, which has been steadily rising, but has begun to taper off in recent years. This may indicate that the consumer is either unable or unwilling to take on new debt.
The consumer is not spending at the rate they had been in the past. And their savings rate, although seemingly on the rise in recent years, is still far below overall average historical savings rate of 8% of disposable income. It should be noted that there is little encouragement coming from the Fed and banking institutions – they are not providing the incentives to motivate people to save. Interest rates on savings accounts are averaging only about 1.1%.
All this, combined with the poor unemployment outlook, reveals the real reason why the Fed and the US government have subsequently accelerated their monetary expansion in the last few years – they must replace the consumer as the primary economic engine by spending enough to close the gap. In fact, the slight (and temporary) positive affects in the economic data recently are solely attributable to government growth, not growth of any significance in the private sector.
Inflation Gradually Destroys the Value of the Dollar
With the Fed repeatedly going to the printing press to gin out more paper money, the government’s unwillingness to divert from its deficit spending sprees, and the average citizen unable to balance personal spending with adequate savings, one has to wonder what all of this is doing to the value of the dollar.
This chart shows what has happened to the US dollar’s purchasing power since the Fed’s inception in 1913. Using the US government’s measure for inflation – the Consumer Price Index (CPI) – the dollar has lost 96% of its value over the last 100 years. And with all that has been discussed above, it looks like this trend will continue until the dollar debasement is complete.
Other Countries’ Currencies are in the same Boat
The US dollar is definitely in decline, as should be obvious by now. But it’s not alone. At this time, all major currencies around the globe have departed from the gold-standard and adopted fiat currencies, with no backing other than the trust in their respective governments (with the possible exception of Malaysia, now experimenting with new gold and silver currencies).
A government subscribes to the use of fiat currencies in order to be able to spend money it doesn’t have. It simply prints up money when it needs to expand governmental programs or go to war. The governments will be successful in this effort as long as the public ‘trusts’ their leaders to be fiscally responsible. But citizens all over the world are waking up to see that their leaders are corrupting and debasing their currencies by printing too much paper money.
Case in point: Europe. Recently, starting with Greece, the European Union has been struggling with too much debt among some of its weaker member states. The so-called PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) are so far in debt, that it has caused genuine concern that their debt problems might end up breaking up the union and throw the Euro, that relatively new currency of the European bloc, to the garbage bin. So the EU along with the International Monetary Fund (IMF) launched a $1 trillion package to save the union and the Euro. And, by the way, the US and other countries around the world contributed to that bail-out package via the IMF.
Unfortunately, this $1 trillion dollar European bail-out package is not sufficient to save all the EU countries in trouble. First, the fund really isn’t as big as $1 trillion, because the member countries contributing to the bail-out fund include the countries being bailed out! (How can a country that doesn’t have any money make any contributions to help pull itself or another country out of the crisis?) Second, Greece and Ireland have now taken approximately $250 billion out of the EU package. It’s estimated that Portugal will take out another $100 billion. Then, once Spain and Italy start down the same path, the fund will need to be increased because the expectations there are $450 billion and $1 trillion, respectively. Because of the US banking industry’s exposure to European debt, the US may once again be asked to join with the IMF to help prevent the European Union from collapsing by giving more monetary aid. The IMF, in fact, has already suggested an increase in the bail-out fund in anticipation of Spain’s debt problems.
Sound familiar? It’s the same story, just different geography.
By printing more money to resolve their debt problems, countries are actually temporarily benefiting themselves because their weaker currencies enable
stronger exports. But again, this is only temporary. As other countries recognize this trade impact, they too will take actions to devalue their own currencies to improve their trading and economic activity. The net result is a global currency war – a race among all nations to devalue their currencies against each other. In such a global economic environment, all individuals who keep their wealth in financial instruments denominated in fiat currencies will suffer the biggest losses. On the other hand, owners of hard assets such as gold and silver are able to preserve their wealth.
Historical Similarities to Current Political and Monetary Policies
As Rome began to fall, there were similar things happening that we see today in our modern society. There was a kind of welfare system, allowing for the dispensing of free bread to those that qualified. Additionally, the Roman republic had a tax system. Included in that system was a taxation of farmers where a certain percentage of crops had to be given for the purposes of feeding the civil servants and soldiers. As this tax percentage increased due to these welfare programs and war activity, farmers began to feel the pinch and decided it was better just to grow a small amount for their own family, and perhaps a bit more for the sake of the government. But soon, the laws were changed so that a farmer had to give a certain tax percentage according to the size of the land the farmer had – so it forced them to work even harder – and for less return on their labor. As this continued, farmers were walking off their land, giving it up and moving away – expatriating.
In addition, the Roman currency, the dinar, was similarly devalued over the course of the empire’s history. At first, Rome used 4.5 grams of pure silver as their coins’ material base. But as the empire grew, so did the debasement of their coinage. Nero decreased the silver content to 3.8 grams – a debasement of about 15%. About 215 AD, a new coin was introduced with only 60% silver content (a 40% debasement). As the empire’s wars went on, the coin’s debasement continued and by 260 AD it was down to 20-40% silver content (a 60-80% debasement). It got worse – they
started issuing bronze coins with silver plating by the millions. In 301 AD the coins issued were only 2% pure silver (a 98% debasement).
In Germany, during the Weimer Republic, the German mark was similarly debased and even resulted in hyperinflation. In 1914, it only took 5 marks to equal one US
dollar. But by 1923, the Weimer government had printed so much paper money that the mark hyper-inflated to a level of more than a trillion marks to the dollar!
There are numerous other examples in history of nations inflating their currencies to death: the French assignate during the French Revolution; the Chinese yuan during the period after 1934; and just recently during the years between 2003 and 2008 in Zimbabwe.
In view of all these monetary fatalities, it seems many of today’s nations are on the same path using similar currency practices and political policies, with the US leading the way with the debasement of the dollar.
Conclusion: Precious Metals like Gold and Silver Provide Protection
After understanding the issues above, one does not need to be an economic genius to see that the price movement of gold and silver is not due to the changing values of those metals. Rather, it’s the value of the dollar and all other fiat currencies that are collapsing! Precious metals act as a hedge against inflation and the destruction of a fiat currency.
In our current world economic situation, it really is a necessity to own physical gold and silver. However, it is not suggested that one rush out and buy these precious metals at any price. Nothing ever goes up or down in a straight line. There will be inevitable corrections, which should be utilized by the intelligent investor to add to existing holdings. Given that the fundamentals discussed above do not change (and at this point, there is little chance of the kind of changes necessary to turn things around), in the intermediate to long term, the value of these precious metals will continue to rise in relation to the world’s baseless fiat currencies.