Over the last 10,000 years, humans have tried two different kinds of “money.” They began with exchanges based on credit — “You give me a chicken… I’ll pay you back later, maybe by helping you build a new wigwam.”
Then, when society became too large and extensive, they switched to gold and silver. The advantage of this was obvious: You didn’t have to remember who owed what to whom. You could settle up right away. “You give me a chicken. I give you a little piece of silver. Done deal.”
Periodically, governments were tempted to go back to credit systems. Essentially, they issued pieces of paper — IOUs — and declared them “money.” Usually, these hybrid systems began with some collateral backing up the paper. Issuers typically had gold in their vaults and agreed to exchange the paper for metal at a fixed rate. Holders of the paper money were told that it was “good as gold.”
In some cases, people believed the IOUs were better than gold. When John Law began modern central banking in France, he backed his paper money with shares in a profit-seeking business — the Mississippi Co. You could take his scrip and imagine that it would grow in value along with the profits of the company.
Trouble was the Mississippi Co. never made any profit. It was a failure… and a fraud. Great prospectus. Few real investments. When people realized, they wanted to get rid of their paper money as soon as possible. In 1720, the system collapsed, and John Law fled France.
Later in the 18th century, the French tried again. This time, the revolutionary government backed its new paper money with revenues from the church properties they had seized. This didn’t last very long, either. The system blew up in 1796. Napoleon Bonaparte, on the scene at the time, declared, “While I live, I will never resort to irredeemable paper money.”
Richard Milhous Nixon didn’t seem to get the memo. In 1971, he changed the world monetary system. Thenceforth, it would be based on irredeemable paper money. We are now in year 42 of this new experiment with modern, credit-based money.
All right so far? Well, yes… as long as you don’t look too carefully.
When you have a system based on credit, rather than bullion, deals are never completely done. Instead, everything depends on the good faith and good judgment of counterparties — including everybody’s No. 1 counterparty: the U.S. government. Its bills, notes and bonds are the foundation of the money system. But they are nothing more than promises — debt instruments issued by the world’s biggest debtor.
A credit system cannot last in the modern world. Because as the volume of credit rises, the creditworthiness of the issuers declines. The more they owe, the less able they are to pay.
As time goes by, the web of credit spins out in all directions, entangling not just the present, but the future too. It stretches out over the entire society… one person owes another… who owes a third… whose debt has been pledged to a fourth… who now depends on it to pay a fifth… all calibrated in the IOUs of sketchy value from a sixth. Have you got that?
Total debt in the U.S. now measures more than twice what it was — in proportion to GDP — in 1971. And GDP itself has been goosed up by credit. Every time someone borrows money to spend… the spending shows up in GDP.
It looks great… on paper. There’s only so much gold. But there is no reasonable limit on how much of this new credit-based money you can create. As it increases, it gives people more spending power. GDP goes up. Employment goes up. Prices — especially asset prices — go up.
Naturally, everybody loves a credit system… until the credits go bad. Then they wish they had a little more of the other kind of money. Wise governments, if there are any, take no chances. They may feed the paper money to the people. But they hold onto gold for themselves. Throughout history, the most powerful governments were those with the most gold.
“Remember the golden rule,” they used to say. “He who has the gold makes the rules.”
When push comes to shove, governments need gold, not more IOUs with their presidents’ pictures on them.
Which brings us to the point of today’s Daily Reckoning.
Britain famously and foolishly sold much of its gold at the very worst time, at the end of the 1990s, when gold was trading at a 20-year low.
But how about the U.S.? Does it have any gold left? That is the question recently posed by Eric Sprott:
“Central banks from the rest of the world (i.e., non-Western central banks) have been increasing their holdings of gold at a very rapid pace, going from 6,300 tonnes in Q1 2009 to more than 8,200 tonnes at the end of Q1 2013. At the same time, physical inventories have declined rapidly since the beginning of 2013 (or have been raided, as we argued in the May 2013 Markets at a Glance), and physical demand from large- and small-scale buyers remains solid.“As we have shown in previous articles, the past decade has seen a large discrepancy between the available gold supply and sales. The conclusion we have reached is that this gold has been supplied by central banks, which have replaced their holdings of physical gold with claims on gold (paper gold).”
“Central banks from the rest of the world (i.e., non-Western central banks) have been increasing their holdings of gold at a very rapid pace, going from 6,300 tonnes in Q1 2009 to more than 8,200 tonnes at the end of Q1 2013. At the same time, physical inventories have declined rapidly since the beginning of 2013 (or have been raided, as we argued in the May 2013 Markets at a Glance), and physical demand from large- and small-scale buyers remains solid.
“As we have shown in previous articles, the past decade has seen a large discrepancy between the available gold supply and sales. The conclusion we have reached is that this gold has been supplied by central banks, which have replaced their holdings of physical gold with claims on gold (paper gold).”
Analyzing the gold sales figures over the last 12 years, Sprott noticed that there was far more gold sold than mined. Where did it come from?
Some of it is easily accounted for in jewelry and private holdings. But generally, the private sector is a buyer and an accumulator of gold, not a seller. And the quantities released to the market have been so great Sprott believes they could have come only from central banks.
But if they have sold such massive quantities over the last 10 years, how much do they have left? Maybe not much.
Which wouldn’t be surprising. Western central banks are committed to their credit money system. They intend to stick with it. And they know that unraveling this unruly skein of credit would be extremely painful.
Selling gold into the bull market of the last 12 years probably seemed like a very smart move. We’ll see how smart it was later, when the credit-based money system blows up.
Dear readers are advised to hold onto their gold. It’s the kind of money that works.
Bill Bonnerfor The Daily Reckoning
Ed. Note: This essay is featured prominently in the Daily Reckoning email edition, which offers a more in-depth analysis of the ideas and themes we feature in our interactive website. Sign up for free, right here, to start getting the full story, sent straight to your inbox every day around 4PM.
Sticking with the big consumer names has paid off in a big way for many investors so far this year.
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill's daily reckonings from more than a decade: 1999-2010.
Where’d the sold gold come from? Its a case of “Old gold boldly sold”— Check out Alisdar McCleod (sp?)interview on the latest Max Kieser episode….He reports the Bank of England, who is storing/holding many people’s gold was quoted as officially physically holding 505,000 – 400oz bars last year in their vault, and now- TA TA TA DUM– is only reporting 400,000 – 400oz bars physically in that vault, thats a whooping difference of 105,000 bars or 1,300 tons of gold GONE out of the vault! Probably “leased out” and sold into the recent market; what a gamble to take with other people’s gold, they may only get paper back in this market, fiat paper, or a promise of “seven years from now” like Germany just got from the USA when they asked for the return 300 tons of their physical bullion.
That’s a nice theory about the evolution of money and markets,…there’s just no socioantropological evidence for it. Therebye relegating it to the same category as other myths. Mt. Olympus, Zues’ lightening bolts, etc. Read “Debt: The first 5000 years”, then rewrite this article founded on academically sound research. Not Adam Smith misinterpreted representation of myth, “The Wealth of Nations”. Economics is not Science – it’s a Value System. The troubling part is, it’s all founded on a fairy tale about how markets developed.
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