247Bull.com Editor: All of today’s currencies are fiat currencies, which means they are money only because the law says so. None of them has any intrinsic value, nor are they backed by any kind of reserves such as gold or silver. This allows them to be continually debased by central bankers via their inflationary monetary policies. This means that modern currencies do not provide a good store of value. For example, over a 20 year period from 1992 to 2012 the US dollar has lost 39% of its purchasing power. Meaning that an item that cost $1 in 1992 would have cost $1.64 in 2012, and this occurred during a period of relatively low inflation. Over this same period the British pound lost an even higher 42.9% of its purchasing power, meaning that an item costing £1 in 1992 cost £1.75 last year. Most people observe this phenomenon and conclude that the cost of goods and services is constantly rising. The truth however, is that our money is constantly losing its value. The reason is that governments continually create more of it in order to finance new spending. To quote Alan Greenspan from his 1966 article, Gold and Economic Freedom, “Deficit spending is simply a scheme for the hidden confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism towards the Gold Standard.”
It is clear that Western capital markets no longer generally regard gold as money. It has been relegated to the status of a risk asset, useful collateral, or simply a commodity with a history of being used as money. This is a mistake.
The great Austrian economist, von Mises, wrote that true money had to survive the regression test. Put simply, it must be established whether or not money had value before it was used as money; otherwise it is only a money-substitute which ultimately depends for its value on confidence. So we need to ask ourselves two questions: what value did gold have before it was used as money, and what value did modern currencies have before they were used as money?
The answer to the first question is clear. Anyone who has seen the Alfred jewel in the Ashmolean Museum in Oxford (over 1,000 years old), the Snettisham torc in the British Museum (over 2,000 years old), orTutankhamen’s gold mask in the Cairo Museum (over 3,000 years old), regard these fabulous items with astonishment. They are simply priceless, being desirable beyond reckoning. There is therefore no doubt that gold, the major element in all these objects, survives von Mises’s regression test. Furthermore the Aztecs and Incas in the New World, completely isolated from Eurasian values, held the same human view.
Paper currencies do not survive this test. They started as money-substitutes for gold or silver and over time lost all their convertibility. As a result they now depend for their value on confidence alone.
Traders and investors in capital markets are unconcerned about this distinction. Instead of realising that Gresham’s Law applies, that bad money has driven out the good, they regard currency as the only money for modern times. This is understandable, because they draw up their accounts and pay their taxes in currency. They invest to make a profit in currency. And so long as they can hedge currency risk by acquiring capital assets, they can manage investment portfolios without recourse to gold.
For these practical reasons mainstream opinion holds that gold is no longer money; but this complacency is likely to be undermined by events. We already see the four major central banks committed to issuing their confidence-based currency in increasing quantities, to finance their governments and to prop up the banks. We have yet to see how they intend to stop doing so.
The effect of monetary inflation was usually predictable. It raised asset prices first, which we are already seeing. It then raised prices of raw materials and manufactured goods, as people started to spend encouraged by low interest rates, leading inevitably to rising prices and rising interest rates. The sequence of credit-fuelled economic cycles is all too familiar.
This time, given the likelihood of a financial and collateral crisis from falling asset prices, the economic cycle is in grave danger of a short circuit. Rising prices for raw materials and goods are likely to be driven by falling confidence in fiat currencies, instead of rising confidence in the economic outlook.
It will be the ultimate test for unbacked currencies. Everyone wedded to modern currencies will then wish they had been aware of von Mises’s regression theorem.