Fiat Currency Fever: The Causes

Note: Any resemblance of this parody to an article published recently by the New York Times is purely intentional.

It is part religion, part politics. It is a way to voice a lack of confidence in individual freedom, property rights, and free market capitalism. It comes from a yearning for a new socialistic, centrally controlled world that happens to favor the elite who control large financial institutions and corporations, and who also exert powerful influence over politicians of both major political parties. It requires the rubbing out of history when the Constitution limited government power and defined what the U.S. dollar is: a certain weight of silver (and later gold).

It is not an investment; it is something that consistently loses purchasing power. It has been created incessantly whenever debt expanded. This elasticity and continual debasement made the use of debt so attractive that nearly everyone got in over his head in mortgages. That historically made sense when inflation was rampant. Now that there is a glut of McMansions and commercial real estate, the Federal Reserve frets about the threat of deflation and promises to spike the punch bowl – if it can.

It is modern fiat currency: bank money that is printed with the click of a mouse whenever a loan is made.

It is tempting to view the screeching halt of the printing of this money through fractional reserve bank lending that occurred in 2008 as something temporary, which will be overcome by levels of government deficits and bank reserve additions that are so extraordinary they dwarf the cumulative totals of the same for decades or since the beginning of time. Such interpretations have fueled critiques of gold’s inexorably rising price as irrational and a bubble, for we know with certainty that Keynesian and monetarist policies are what swiftly carried us out of the Great Depression. These policies were safe and inflation was tame for decades afterward.

But I think it reflects first and foremost a dismay that the economy remains mired with Depression-level unemployment and collapsing housing prices, and holdout hedge fund managers that refuse to give up the notion that there is something wrong about this recovery. Even worse, the populace just won’t cooperate and go further into debt, even if this would be foolhardy after the largest housing binge ever and impractical now that baby boomers are aging beyond the nesting years. Even more worrisome, this unruly mob has the gall to consider voting for candidates that challenge the establishment of both major political parties!

Or, as a friend of mine put it, “You are buying Treasury bonds, munis, and junk credit at 50-year lows in yields because the state and federal governments will never go broke, and they represent the real, intrinsic power governments possess to tax the populace with impunity.”

It is not easy to have a calm discussion about fiat currency and the fractional reserve banking system, because even in our most prestigious universities we were taught that gold is a barbaric relic of an earlier era. And no one really knows what fractional reserve lending is anyway. No one can agree what type of inflation matters. They believe inflation can only be measured through consumer products, but raw commodities or assets like stocks, bonds or real estate that can be leveraged or sliced and diced through derivatives are exempt from the analysis, and these are more readily influenced through the extension and contraction of credit.

If you are in the mainstream, you probably look at your bank deposits as 100 percent safe. This is because it is inconceivable that in the modern world where the Treasury and the Fed are omnipotent, a little thing like the falling in value of the one asset at the core of our crisis, real estate, can’t possibly wipe out the thin veneer of equity most banks have to buffer their depositors. On the other hand, if you are suspicious about Fed policy and stimulus spending, you have probably adopted the view that these reckless actions will cause rampant inflation, because if that is what Ben Bernanke wants, he’ll get in his helicopter and just do it. He said he could do it in a 2002 speech. But in Jackson Hole in August 2010 he said he never would, because increasing “medium term inflation goals above levels consistent with price stability had “no support for this option on the FOMC.” So, in November he announced he would just do it a little bit.

It is a shame the suspicious among us are too Neanderthal to understand this nuance. It’s a waste of perfectly fine paper to organize a tea party to throw the contents of the QE2 overboard. They should trust Bernanke, because he is smarter than they are since he is ranked fifth on Foreign Policy magazine’s list of the top 100 global thinkers. You know he probably would have beaten out Obama for number three if he had gotten a Nobel Prize instead of his mentor this year. If he had been the tipee rather than the tippor of information regarding who was going to be on the receiving end of the free money the Fed was handing out, instead of Buffett and Gates he might have been named number one. Not everyone can be brilliant and know which huge financial institutions would be saved or not. Heck, if you were just an amateur investor, you might have bought a certain large insurance company that was the mark guaranteeing all those derivatives.

Back in the 1990s (and even decades prior to that) when credit was expanding to twice its ratio to national income that was seen in the last peak – 1929 – no one questioned the era of growth around the world, and it was the time when central bankers convinced governments that they deserved independence in the pursuit of wise monetary policy.

But the last decade was another matter, as was the late 1970s. Like the 1970s, this decade is about to end, so of course the gold rally this time is just about to end. It doesn’t make any difference that the 1970s and this decade are polar opposites; they are the same because gold went up a lot both times. Each was the result of excessive risk taking, which of course could never be caused by having a broad money supply that doubles every seven years or so due to fractional reserve lending. We have the luxury of saying only what pleases us elites, since we are no longer tethered to justifying what we do with rational economic theory. This is because there is no modern economic theory outside of the Austrian School that has not been thoroughly discredited, or which can claim to have been useful in forecasting or averting the crisis, or whose solution can be convincingly shown to have done little else other than kick the can down the road. So let’s just go for it!

If you, like me, have no clue what the word “fiat” really means, you could argue that having gold behind a currency is also a form of fiat, that gold should be worth its value as a commodity rather than seen as a great and perpetual store of value. After all, holding dollars or any other fiat currency in the history of man turned out to be a total loss in the long run and subject to near total debasement when looked at over half-centuries or centuries, or sometimes just decades. Why should the world decide that something found in South Africa is more valuable than this?

We all know gold really is the same as paper currency, save for one oddity that isn’t relevant in modern times: It does not deteriorate with age. Gold mined 1,000 years ago may be in that ring on your finger. Other things do not last. So, electrons do, right?

A disadvantage of gold as an investment is that it is not an investment and in any previous monetary system, it wasn’t intended to be! You should love paper because even if it did not provide any investment return in the last cycle back when yields were higher, this time it has almost no yield, and its real risks are now guaranteed by the Bernanke “put.”

You know, the central banks of Europe and the U.S. were so all-powerful that they were able to suppress the price of gold for decades after Franklin Roosevelt initiated this era’s multi-generational credit inflation. You could go broke betting against that! It’s a long shot at best, even if all the other central banks out there might be clamoring for the right to counterfeit money as fast as we do, all the while secretly snapping up gold in the physical market.

If you are buying gold because you are a bitter clinger that is brainwashed by those hypesters who rip off listeners advertise with Glenn Beck, Rush and Sean, just ignore gold’s having trounced all other major currencies over time. Believe me, the only reason why gold goes up is because the dollar goes down. We all know that in the 1970s gold underperformed those other currencies, right?

O.K., the Chinese manipulate the renminbi so maybe things are a little different now. Even if China suffers from inflation, which seems to be accelerating, we know that westerners are so dumb they would flood into it and drive the price up. But of course China’s central planners are even wiser than ours, so they would never allow that, and the Chinese would continue to export until they made absolutely everything contained in a Wal-Mart store in exchange for our fiat currency. The Chinese people would then swap our fiat currency for theirs and make everyone with Communist Party ties millionaires. Only when they take Wal-Mart private in the world’s largest LBO, buy Rockefeller Center, and buy Pebble Beach to raise greens fees to $1,000 will we know the new, new reserve currency bubble is over.

The international furor over the Fed’s quantitative easing shows how sensitive our trading partners are to the prospect of our counterfeiting faster than they can with their presently less fungible paper. That is why those gold bugs have really gone off the deep end. They just don’t understand that other countries like China expand the renminbi supply by freshly printing 20 to 30 percent of their money annually, so the dollar is actually inherently a strong currency! Why would you ever own gold knowing that? You should be snapping up Chinese real estate and stocks instead, because it is like shooting fish in a barrel when the currency chasing up real estate prices is expanding that fast! We got our chance to have a bubble, now its only fair to put the kibosh on the Fed’s printing money and let the other counterfeiters have their time in the sun. While we’re at it, we should sign the Kyoto Protocol and pass Cap-and Trade right away, because we should stack the deck in every way possible against ourselves.

If you are tired of seeing a zillion for sale signs languish on your neighbors’ lawns, and you can’t figure out why your house value is sinking even though you can swear talking heads told you a rebound was underway and REITs have been among the best performing sectors in the stock market, then let’s gleefully think about how nice it would be if the stagflationary 1970s returned, even if Jimmie Carter went down in flames amid the “malaise.” You know, nominal incomes went up and we all began to experiment with using lots of debt, just like how we as baby boomers tried marijuana but did not inhale.

But darn it, even though I told you the 1970s were just like the last decade, I have no theoretical basis for anything I am saying, and the current news flow isn’t making any sense. Governments like Ireland and England are choosing to cut back upon government jobs and slash entitlements instead, just when Keynsian policy is needed the most. What’s even weirder is that Ireland never ran a big deficit, but now it is looking like it would be bankrupt unless Germany bails it out. Why would the Germans give money to the Irish, which would turn it over to bail out investors who bought risky bonds in too-big-to-fail banks? Who cares if the lenders were large German banks, we’d better save the rigged free market system or else those conspiracy theorists who are buying gold might infect the academic sensibility of people generally.

Complaining that only a few elites would benefit while 20 percent of the people would lose their jobs and maybe their homes may sound just and reasonable, but there is a big difference between what would be nice and what is really going to happen. You people reading this are just plain stupid, so you will never be able to fight elitists like me. So don’t even think about draining your bank account and buying Krugerrands or American Eagles. Whether you know it or not, you’ll borrow more. In so doing, you’ll keep the world’s governments afloat, even if you think you can stop us from raising taxes to pay for the mess we’re in, the bailout of Wall Street, and the enrichment of insiders that got guarantees on buying into failed institutions that nature would have euthanized.

Why gamble on gold when you can own the casino and fleece the public whether their number comes up red or black? Let’s hope the elitist bet comes up a winner no matter what, because if you buy gold and force the government to stop diluting your savings and spending us into a heavily indebted oblivion, you would actually get back your individual freedoms and property rights. Just like the night before TARP, you should be deeply afraid, because the truly free market that might be unleashed would be a complete disaster compared to what we have now!


Bill Baker,
for The Daily Reckoning

[Editor’s note: This passage is reprinted from William W. Baker’s book, Endless Money: The Moral Hazards of Socialism, with the permission of John Wiley & Sons, Inc (©2010). You can get your own copy of his book here.]

The Daily Reckoning