Because we view fiat (i.e., government created and controlled) currencies as the root cause of the financial world’s many problems, we see the failure of these currencies and their replacement with something better as both inevitable and imminent. Because gold was humanity’s money of choice for the 3K years prior to 1971 — during which time it worked very well — we think it will be central to the coming transition.


Gold’s exchange rate. An old Chinese proverb says wisdom begins with calling things by their right name. In the financial media, gold is generally presented as having a “price,” but this is incorrect, because gold is not a consumable commodity like oil or eggs. Gold is money, and since we don’t talk about the price of euros or yen, but instead discuss their “exchange rate,” in this book we treat gold in the same way.


Crisis equals opportunity.


The danger is what everybody sees; the opportunity is never quite so obvious as the danger, but it’s always there.


Today’s world of rising debt and ever-greater financial instability certainly feels like uncharted territory. But that’s only because we humans have such short life spans. From a historical perspective, what’s happening is depressingly familiar. Over the centuries dozens if not hundreds of societies have borrowed too much and then, wittingly or not, destroyed the currency in which their debts were denominated. In most cases this play has consisted of 3 acts: excessive borrowing, “blow-off” inflationary bubble, and catastrophic economic crash.


In fact, for as long as there have been money and markets, societies have been passing through the same sequence of cultural moods, beginning with anxious conservatism in the aftermath of hard times, followed by cautious optimism and finally — as the original “depression-era” generation is replaced by its memory-impaired grandkids — let-it-all-hang-out financial excess. A horrendous debt-driven economic crash (or its geopolitical / military equivalent) then resets the cycle.


This insight burnished his professional reputation but alarmed the Soviet Union’s leaders, whose Marxist theology envisioned a linear world moving from capitalist oppression to workers’ paradise rather than a cyclical one.


Long Wave theories are derived from history and until very recently, most money was sound — that is, based on gold and / or silver, tangible assets that existed in limited supply. When debts rose to debilitating levels, borrowers were unable to acquire enough (scarce) money to pay off their loans and defaulted en masse, causing the depressions that generally followed extended booms.


Today’s central banks can create as much new fiat currency as they choose, and the global economy continues to accept it as money. This widespread and systemic gullibility allowed the US government to more than double its already-excessive national debt between 2007 and 2013. And it is allowing Europe to, in effect, move much of the debt of Greece, Spain and Portugal onto Germany’s balance sheet without setting off a financial panic or revolt. And it is enabling the Japanese government to borrow more, as a percent of its economy, than any other major country in history. None of this profligacy would have been possible in a sound-money environment.


So the question becomes one of timing. At what moment and under what circumstances will a critical mass of people realize that more currency does not equal more wealth?


Which snowflake will set off the global financial avalanche can’t be predicted in advance. But there are dozens of candidates. A broad Middle East war could send the price of oil soaring. The eurozone could begin to fragment, as peripheral countries like Greece and Spain realized that they can’t live under the same monetary regime as Germany. A major bank’s derivatives book could blow up. Interest rates could spike, setting off a death spiral in government finances and / or the implosion of the leveraged speculating community.


An asset class is in a bubble when:

  1. Its price rises far beyond what rational analysis would have deemed reasonable just a few years before.
  2. Individuals in the market begin making apparently easy money doing things that experts used to find difficult. Think day-traders and house-flippers in the dot-com and housing bubble.
  3. Tried-and-true business practices are replaced with “innovations” that in more rational times would be seen as harebrained ideas at best or scams at worst: Focusing on “eyeballs” rather than earnings when valuing tech stocks or eschewing conforming loans in favor or liar loans and interest-only mortgages.
  4. They can be identified fairly early in their lifecycles, but tend to go on longer than reasonable analysts expect.
  5. As a bubble forms, a unique mantra emerges to justify its excesses. During the real estate bubble, the idea that “home prices only go up” became the conventional wisdom, even though logic or a cursory analysis of historical prices could have proved it wrong.

Today’s fiat currencies emphatically meet the above bubble criteria. The prices of government bonds denominated in euro, yen and dollars have risen to extraordinary levels (which is the same as saying interest rates have been forced to extraordinarily-low levels). And befitting its size and scope, this bubble is rationalized with 2 popular mantras: the sovereign debt of countries with a printing press is “risk-free,” and those same governments can use their printing presses to control interest rates and boost asset prices — forever.


A tangible asset to eliminate payment risk (this is the least familiar aspect of money). The underlying principle of all commerce is that goods and services pay for goods and services. So a shopkeeper accepting a fiat currency in payment has not actually “extinguished” the transaction until he uses that fiat currency to purchase some other good or service. In the interim he faces “counterparty risk,” the danger that the purchasing power of his pieces of paper will decline due to inflation or devaluation, be lost in a bank failure, or be repudiated and replaced with some new paper currency of lesser value. In other words, fiat currency is in effect an IOU, the value of which depends on someone else — in this case the government — keeping its promises.


Currency, meanwhile, is the form money takes when it circulates. But it is not always money itself. When a paper is printed to represent the gold or silver in a government’s vaults, that paper is not money but a “money substitute.” It can be spent and even saved as if it was metal, but the 2 are not identical.


But this store-of-purchasing-power function — dependent as it is on a limited supply of monetary metals — is actually a drawback for governments in need of resources to fight wars and maintain the support of powerful constituents. So every so often a country decides to replace gold and silver with a more plentiful and easily-manipulated substitute. In other words, they choose political expediency over stability, and adopt “unsound” money.

The result, in every recorded case, has been the same: Released from the discipline of a limited amount of money supply, government goes a bit wild, creating so much new currency that its value evaporates. After a period of chaos, the traumatized society has — in every single case — returned to some form of sound money.


But the pressures of running a far-flung empire while placating “the people” led to steadily-rising government spending. Successive emperors addressed this mounting budgetary pressure the dishonest way — by mixing cheap, plentiful copper into their silver coins. By around AD100, the denarius contained 85% silver. By 218 the figure was 43% and by 244, only 0.05%. Romans, as their money became increasingly impaired, found it harder to figure out what things should cost and began to doubt the future value of their savings. They began to convert coins into tangible goods, whatever the cost.


In 1919, 12 marks were worth $1. By 1921 the dollar bought 57 marks and by October 1923 170B. Here again, the savings of a generation was wiped out, setting the stage for a dictator to take power.


To state the them up front: When armed with a printing press, a nation tends to respond to every problem in the same, politically expedient way by throwing newly-created money at it. But as with any other form of addiction, the dosage has to keep rising to produce the same result - until the level becomes fatal.


The surprising profligacy of the 1990s illustrates an important point about public finances, which is that there are several ways to cover the costs of rising government spending.

One is to raise taxes, which is honest but difficult because it is both visible and guaranteed to enrage important constituencies.

The second is to borrow the excess, which is less obvious and therefore more frequently chosen by leaders who can get away with it. That was the 1980s.

The third strategy is to encourage the private sector to do the borrowing. For a sense of how this work, pretend for a moment that the availability of cheap mortgage financing convinces you to build your dream house. Your decision creates jobs for carpenters, plumbers, bankers and furniture makers, all of whom pay taxes on their new income. The government takes in more revenue and therefore needs to borrow less. But total societal debt rises by just as much as if the government borrowed that money instead of you.

This strategy is even harder for most people to understand than deficit spending. And even when understood it’s hard to dislike because initially it feels great. Individuals find jobs and credit plentiful while the value of their homes and investment soar. Politicians can point to falling deficits as proof of their responsible stewardship. And businesspeople are energized by dreams of commercial empires built with other peoples’ money.

That, in a nutshell, was the 1990s, as the Fed repeatedly cut interest rates and encouraged home buying and corporate empire building.


Large US banks including Goldman Sachs and Citigroup were owners of billions of dollars of Mexican bonds which would plunge in value in the event of a default or major devaluation. So President Clinton proposed that Congress bail Mexico out directly. When Congress balked, US Treasury Secretary (and former GS co-chairman) Robert Rubin simply gave Mexico $20B of currency swaps and loan guarantees from the Exchange Stabilization Fund, a Treasury account that as Treasury Secretary he controlled, in effect bailing out his former employer and the other major banks. Mexico stabilized and the crisis subsided — but a lesson was learned: When big US banks are threatened, the money will be found to protect them.


By the mid-1990s hot money was pouring out of the US and into the “Asian Tigers,” up-and-coming countries like Korea and Thailand that were replicating Japan’s export-driven growth model. But too much of a monetary good thing leads to bad decisions, and the productivity of new investments had been falling for a while. Then China devalued its currency and the US raised interest rates in response to an “irrational exuberant” stock market. The dollar rose strongly and hot money started pouring out of the Asian tigers and into suddenly-higher-yielding US bonds. The Tigers’ economies began to implode.

Here again, much of the money at risk was owed to large US banks, and the response was swift. The IMF (using mostly American capital) began a multi-billion dollar bailout of the Asian economies, while the Fed reversed course and cut interest rates to lower the value of the dollar and reduce bank borrowing costs. The panic subsided within a few months.


So much money had been bet on so many unworkable business plans and ridiculously overvalued stocks that trillions of dollars simply evaporated from Americans’ nest eggs and bank balance sheets. A recession was unavoidable, and a Depression was very possible — right on schedule from a Long Wave Theory point of view. So the Fed once again cut interest rates.

Then came the WTC attacks of September 11 2001, which threatened to terrify consumers into becoming savers, thus depressing the economy even further. And the Fed, as if the past few crises were just warm-ups, opened the floodgates. It cut interest rates dramatically and made it clear to all concerned that it was there to backstop the economy with easy money.


Homeowners began using their houses like ATMs, extracting cash via home equity credit lines and using the proceeds to buy cars, vacations and more houses. And last but not least the share prices of home builders, big banks, mortgage lenders, and virtually everyone else associated with the housing business soared to record levels, taking the overall stock market along for the ride.


The money rate can, indeed, be kept artificially low only by continuous new injections of currency or bank credit in place of real savings. This can create the illusion of more capital just as the addition of water can create the illusion of more milk. But it is a policy of continuous inflation. It is obviously a process involving cumulative danger.


When the economy didn’t respond to the bank bailout — and the banks remained hobbled by the looming default of trillions of dollars of bad loans and derivatives — the Fed dusted off a theoretical idea called “quantitative easing,” in which the central bank buys bonds on the open market, paying for those securities with newly-created currency. (“Quantitative” refers to the increasing quantity of money, while “easing” refers to reducing interest rates to make cheap capital readily available to banks. This practice is also known was “debt monetization” because it turns debt into circulating currency.”)

The goal was two-fold: First, to enable the US government to borrow unprecedented amounts of money and spend it in an attempt to revive the economy. Second, to “recapitalize” the banks, keeping them alive and — hopefully — convincing them to start lending again.


In September 2012 it announced that it would buy $40B of bonds per month until its definition of normal life — more debt and spending — resumed. In December 2012 this was raised to $85B a month and dubbed “QE-infinity” because of its indeterminate lifespan.


Taking together, ZIRP, the QEs and the Fed’s other departures from tradition and historical precedent have changed the US financial system almost beyond recognition. The Fed’s balance sheet soared (because of the securities it has purchased from the banks) from $850B in 2007 to nearly $4T by the end of 2013. The banks, meanwhile, saw a corresponding huge increase in their reserves, giving them the ability to flood the system with many times this much in new loans.


In the 1990s, Japan suffered through the simultaneous bursting of equity and real estate bubbles and responded by borrowing huge amounts of money and propping up its banks and builders.

This strategy worked, in one sense, because Japan’s financial sector did not collapse. But disaster avoidance came at a price, which was the creation of a whole generation of “zombie” companies that couldn’t function without continued infusions of public money. As a result, one stimulus program followed another, ballooning Japan’s public debt to levels that, as both a percent of GDP and of government tax revenues, dwarf those of any other major country. The economy, meanwhile, remained in a kind of twilight, neither growing nor shrinking while the debts continued to mount and domestic deflation (via an increasingly valuable yen and steadily falling real estate prices) made those debts even harder to manage. By 2013 Japan’s government owed an amount equal to about 22 times its annual tax revenues, an imbalance far greater than those of other mega-debtors like the US and Greece.


But this was “success” only in the sense that giving an addict another, even bigger shot of heroin succeeds in alleviating withdrawal symptoms — for a while. The underlying problem, the continuing accumulation of debt across the developed world, continues, and is now at levels that can only be called catastrophic.


When a person buys something, they judge their purchase according to 2 criteria: how to useful it is, and how much it costs. If utility outweighs price, they’ve received a good deal. Put another way, something is only worth having if you don’t overpay for it.

This principle tends to be ignored in the reporting and analysis of most economic statistics, which focus only on headline numbers like GDP growth and employment while failing to mention the borrowing that was required to get those results.


In the US, benefits promised to future recipients of Social Security and Medicare are very real obligations (imagine cutting retirees’ health care and then running for re-election), arguably more real than bond interest owed to China or Saudi Arabia. So it makes sense to view them as a form of debt. When these unfunded liabilities are folded into the US federal deficit calculation, the annual figure soars from the $1T of recent years to over $6.


Amazingly, the liabilities described in the previous chapter aren’t the scariest issue facing today’s financial world. That distinction belongs to the over-the-counter derivatives, unregulated contracts between financial institutions in which each “counterparty” takes one side of a bet of interest rates, currency movements, bond default or pretty much anything else that moves. Because there is no limit on how many contracts can be written on a given bond issue or currency position or whatever, the amount of derivatives that can be created is effectively infinite. As a result, banks and hedge funds now treat this market as a casino, making bets and collecting fees in ever-increasing amounts. The face value of all derivatives outstanding in 2013 was about $693T, or nearly 10 times the size of the entire global economy.


In 2008, money center banks’ seemingly-modest net derivatives exposure was revealed to depend on counterparties like Lehman Brothers, Bear Stearns and AIG. When those firms imploded, one side of trillions of dollars of derivatives defaulted, leaving the remaining counterparties suddenly “un-hedged,” that is, liable for other contracts without the expected protection from the now-defaulted contracts. The “net” derivatives exposure became irrelevant while the gross number became real, with near-catastrophic consequences for the global financial system.


The global derivatives markets in the post-Lehman period, despite considerable compression of bilateral positions, are unstable, and they can bring about catastrophic failure. Quite simply, a threat of failure to any of the major banks is an immediate threat to the others. The network topology where the very high percentage of exposures is concentrated among a few highly interconnected banks implies that they will stand and fall together. This topological fragility of the derivatives market as risk-sharing institutions has an implicit moral hazard problem that undermines their social usefulness.


The American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.


The story begins in 1971, when the US broke the formal link between the dollar and gold. Henceforth the dollar was a purely fiat currency which the US could create in infinite quantities. But it was also the world’s reserve currency, and therefore in great demand virtually everywhere. In effect, the US found itself in possession of a seemingly unlimited credit card, which it proceeded to max out. Among other things, it built a global military empire, a cradle-to-grave entitlements system, and a consumer society that encouraged individuals to buy whatever they wanted on credit. Debt soared, too much new currency was created, and the value of the dollar began to decline.


“President Obama has decided to have the director of the US Census Bureau work directly with the WH to make possible oversight of the director by the senior WH aides.” And in November 2013 The New York Post reported that Census Bureau analysts, allegedly under orders from superiors, fabricated data that went into unemployment reports leading up tot he 2012 presidential election.


Meanwhile, in today’s fiat money system, the government, Fed and major banks get to use that newly-created currency before its rising supply lowers its value, giving a huge advantage to the government-sanctioned banking monopoly. And banks — facing the pressures mentioned earlier — have been using this money in increasingly aggressive ways, creating products like asset-backed bonds, junk bonds, and over-the-counter derivatives that generate fees in the moment but vastly increase systemic leverage and fragility. In effect, the largest banks have become hedge funds, rolling the dice with the depositors’ money.


In the aftermath of the Great Depression, the Glass-Steagall Act of 1935 divided the banking industry into commercial banks, which were banned from risky investments in return for the government guaranteeing their depositors’ money, and investment banks that were free to make big bets on pretty much anything while putting their partners’ and investors’ money at risk. This division kept the banking system from behaving too crazily for several decades.


And in 1999 they were finally powerful enough to overturn what was left of Glass-Steagall. With the stroke of a pen, the final distinctions between commercial bank, investment bank, and hedge fund largely disappeared.


The term for this buying of official favor is “regulatory capture,” and lately it has become a major profit center for powerful industries. A few million dollars directed to the right political campaigns can yield billions of dollars in advantages over competitors.


Now assume that the government, in order to finance its deficits and create lots of speculative opportunities for large banks, chooses to depreciate the dollar by 8% a year (while reporting inflation of only 2%). The purchasing power of the dollars in the Bob-the-saver’s bank account actually falls in real terms by 6% a year.


Seeing similar things happening all around them, Bob and Martha’s friends and neighbors make the rational decision to emulate Martha, producing a society in which everyone borrows and no one saves. Which is exactly what the US has become. The national savings rate fell from an average of 12% in the 1970s to less than 3% in 2007. The grasshoppers now vastly outnumber the ants.


They found that many looked the same and cost more-or-less the same as previous versions, but contained slightly fewer tissues or nuts or whatever.


The amount of money being devoted to surveillance is immense. In 2013 the Washington Post reported that the so-called “black budget” was $52.6B — or only slightly less than Japan and the UK spend on their entire militaries.


Interest rates are, in effect, the price of money and as such they’re a crucial signal to virtually everyone in every market. When rates are high, that’s an incentive to save, because the resulting yield is attractive. Low rates, meanwhile, are a signal that money is cheap and borrowing is potentially more profitable than saving.

Prior to WW2 interest rates were set mostly by supply and demand. When there were lots of productive uses for a limited supply of money, demand for it went up and interest rates rose, and vice versa. Market participants had a fair idea of what the economy was asking for and government generally let them respond to these signals.

When the Fed began playing a bigger role in the economy in the 1950s and 60s, it chose as its main policy tool the Fed Funds Rate, the rate at which it lent short-term money to banks. Long-term interest rates (i.e., the bond market) remained free to fluctuate according to the supply and demand for loans. But following the crisis of 2008 the Fed and other central banks expanded their focus from short-term rates to all rates, including long-term. Today, the Fed intervenes aggressively “across the yield curve,” pushing short rates down to zero and buying enough bonds to push long-term rates down to historically-low levels.


Because gold is a competing form of money, when it rises in dollar terms it makes the dollar and the dollar’s managers look bad. So for nearly 2 decades the US, along with several other governments and their central banks, has been systematically intervening in the gold market to push down its exchange rate to the dollar.


What happens to a society when market signals are distorted by the government? In a word, “malinvestment.” Factories are built that produce the wrong things, houses are bought that cost more than their owners can afford, bank CDs are cashed in to buy stocks just before a market correction, gold and other hard assets are converted to paper currency when they should be accumulated and held for the long haul.


Whenever destroyers appear among men, they start by destroying money, for money is men’s protection and the base of a moral existence. Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values.


When people realize they’re being misled by their leaders, one typical response is to refocus closer to home, on friends, local producers of necessities, local government, and family — in other words, the people and organizations that can be seen and judged face-to-face. This is called “shrinking trust horizon.”


But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. Everybody is anxious to swap his money against “real” goods, no matter whether he needs them or not, no matter how much money he has to pay for them.


One of the great mistakes is to judge policies and programs by their intentions rather than their results.


Retirees tend to spend rather than save, which means less domestic demand for government bonds.


Americans are living beyond their means and shifting a part of the weight of their problems to the world economy. They are living like parasites off the global economy and their monopoly of the dollar. If in America there is a systemic malfunction, this will affect everyone. Countries like Russia and China hold a significant part of their reserves in American securities. There should be other reserve currencies.


There have been 2 previous currency wars in modern times. The first was during the 1930s when the US and the major European countries, suffering from the debasement of currency created to pay for WW1 and the collapse of the 1920s debt bubble, either went off the gold standard or sharply devalued versus gold. The second was during the 1970s when the US ended convertibility of dollars into gold, setting off a decade of monetary chaos in which inflation hit double-digit levels and gold soared from $35 to $850.


As dollar, yen and euro interest rates have plunged in recent years, hedge funds have been able to borrow virtually unlimited quantities of major-country currency for next to nothing. Meanwhile, developing countries like Brazil, Thailand, and Russia offer bonds yielding far more than US Treasuries. So speculator — on a vast scale — have found it profitable to borrow dollars or yen, use them to buy, say, Brazilian bonds, and reap a wide, lucrative spread, which is frequently made even wider when capital inflows strengthen the developing country currency.

This “carry trade” is great for the developed world in general and hedge funds in particular, but not so much for developing countries, where alternating in-and-out torrents of hot money can destabilize smaller, more fragile economies, leading the latter to resort to the kinds of centralized planning that frequently do more harm than good.


The combination of the dollar’s reserve currency status and America’s willingness to blatantly abuse the resulting advantage is a huge problem for much of the rest of the world. Consider the situation from the Russian or Chinese point of view: You not only face torrents of hot money pouring in and out, severely distorting your economy. But your desire to be a great power, at least in your neighborhood, is continually stymied by the omnipotent US military — which is paid for with newly-created reserve currency. The dollar’s dominance, in other words, is a key to America’s ability to bully other countries not just economically, but militarily.


China is obviously the key player here, with good reason. Its economy is the world’s second largest but its currency accounted for less than 1% of foreign exchange transactions in 2012.


In 2011, Ron Paul actually introduced a bill that would cancel the $1.6T of Treasure debt then held by the Fed and simultaneously lower the debt limit by that amount. “Where did they get the money to buy our debt? Well, they created it out of thin air. It’s a fictions debt. It’s a dishonest debt and I would say that we’re not obligated to pay it off.”


The original banks were essentially very safe warehouses.


The goldsmiths then noticed something else about their new paper-money invention: Only a tiny fraction of their clients asked for the return of their valuables in any given period, which led to a bright — but legally and morally-dubious — idea. Why not start issuing receipts in excess of the gold and silver on hand?

“Fractional reserve banking” was thus born of deception if not outright fraud, because for the receipts to retain their value the goldsmiths had to pretend that those paper claims to gold and silver were backed by an equal amount of metal and were therefore of equivalent value. They were not, of course, because a tangible asset is more valuable than a promise to pay a tangible asset, particularly when the latter outnumbers the former.

The goldsmiths, having evolved into more-or-less recognizable bankers, then realized that more deposits equaled more profits. So they began paying people for deposits of gold and silver rather than charging for their storage, thus inventing the interest-bearing account.


The result is an “elastic” money supply. When borrowers are optimistic and want to increase their borrowing, banks in a fractional reserve system can in the aggregate offer them immense amounts of new credit. So the money supply, instead of being determined by the amount of gold, silver or other bank capital in the system, can expand dramatically to accommodate an energetic society’s demands.

But it can also contract dramatically. If an economy that has greatly increased its money supply through bank lending suddenly takes a downturn or is unnerved by an unexpected crisis, borrowers will pay off their loans or default on them and banks won’t replace them, while depositors seek the return of their cash. These actions cause the money supply to collapse, potentially all the way back to the level of base money in the system. The result of this fluctuation in the supply of circulating currency is a recurring series of booms and busts that wipe out businesses, individuals, and banks and frequently send the general economy into recession or depression.


The US government responded to the imprudence and outright corruption of the 1920s by passing the Glass-Steagall Act of 1933, which separated commercial banks, which were to focus solely on the needs of commerce, from higher-risk activities that would henceforth be permitted only within investment banks. To further reassure the public, the government provided insurance for commercial bank deposits, and hired regulators to monitor bank solvency.


In the 1980s, most Wall Street investment banks “went public,” selling shares to outside investors. The infusion of new capital both enriched the original owners and changed their incentive structure. By the 1990s, both commercial and investment banks were playing mainly with investors’ money and were thus encouraged to take ever-bigger risks, safe in the knowledge that immediate profits would translate into huge year-end bonuses and a higher stock price, while the resulting problem might not manifest for years — by which time the architects of those strategies would be retired.


The only viable solution for monetary stability is to get government out of the money business permanently. The way to bring this about is through currency competition: allowing parallel currencies to circulate without any one currency receiving any special recognition or favor from the government.


Early in the development of fractional reserve banking, the system’s inherent instability became apparent to the goldsmiths cum bankers, who after all were personally threatened by bank runs. They convinced governments to create a new kind of bank, called a central bank, to act as a lender of last resort to prevent bank runs from spreading. From a banker’s point of view the central bank’s real job was to prevent individual lenders’ bad decisions from threatening the rest of the financial community.


During the Classical Gold Standard, which ran from 1700 to 1914, banknotes circulating as currency were, in effect, warehouse receipts for a nation’s precious metal reserves. Put another way, the dollar, pound, and franc were simply names for different weights of gold or silver.


But governments chafed at the restrictions on spending imposed by a limited money supply, and with the outbreak of W1 began to leave the gold standard and adopt unbacked fiat currencies which they could create as needed. In order to preserve their new power, governments expanded the role of central banks to include setting interest rates and deciding how much currency to create, without reference to any external limit. This discretion gave central bankers immense power and importance.


In modern times, the best example of a truly independent central bank was the German Bundesbank, which was designed by the victorious powers after WW2 to be immune to political pressure in order to prevent Germany from using the money-printing ability of a central bank to rearm and start another world war. The perhaps-unintended result was several decades of near-perfect monetary policy to make the German mark one of the world’s strongest currencies, while restoring Germany to its prior industrial glory in a single generation.


Central banks have become de facto if not de jure branches of their governments. In 1977, the Fed was given a “dual mandate” that made full employment one of its stated goals, virtually guaranteeing excessively-easy money from that point forward. In 2013 the incoming Japanese government simply demanded that the BoJ target and achieve a 2% inflation rate — and the BoJ acquiesced.

This combination of commercial banks now invented to take extreme risks and central banks under the control of politicians has produced exactly the kind of world one would expect, in which finance dominates production and seemingly-insane amounts of leverage are not just countenanced by the authorities but encouraged.


An abundance of literature exists to explain why central planning is doomed to failure. Their conclusion is that government’s main role in a modern economy should be to create a stable, predictable stage on which the market’s “invisible hand” can operate. This doesn’t preclude reasonable regulations, especially in the realm of banking, but it does require that the rules be clear, widely-understood and equitably enforced.


Modern central bank / fractional reserve banking system has 3 notable flaws:

  1. It depends on perception. If enough people begin to mistrust their banks, then “runs” spread from one to another until all the bank fail.
  2. It inevitably destroys its currency. Today’s system can create virtually unlimited amounts of credit. But credit is not wealth.
  3. It distorts markets and misallocate resources.

Whenever fractional reserves are permitted, the banking system comes to resemble a classic Ponzi scheme which can only function as long as most people don’t try to get at their money.


Most people — and certainly most governments and economists — define inflation as a general rise in prices. But this is wrong. Inflation is an increase in the money supply, and a higher general price level is just one possible result. In fact, excessive money creation most frequently shows up as asset bubbles, where the new money, instead of flowing equally to all the products that are for sale at a given time, flows disproportionately into the “hottest” asset classes.


When US Treasuries and IBM certificates are museum pieces, gold sill still be money.


Wealth comes in many forms, but only 2 general categories: tangible and financial.


Financial assets like bank deposits, insurance policies, bonds, and annuities do have counterparty risk, which is to say they depend on someone else’s promise. A bank deposit only has value if the bank is willing and able to return that money when the account holder requests it. Even an insured bank deposit is only as good as the financial capacity of the government or insurance company standing behind the bank. And a piece of paper currency is only valuable if the government manages the money supply properly.


Over long periods of time these 2 asset categories tend to move in and out of favor, with tangible assets being more prized in hard, uncertain times when preservation of capital is paramount and counterparty risk is suspect, and financial assets being favored when times are good and people have grown to trust major institutions and governments to keep promises and generate big returns.

One of the keys to successful money management is to understand which category is ascendant and therefore the more profitable / safe place to be. During a boom, one should own financial assets until they become relatively overvalued then shift into tangible assets and own them until they become overvalued.


The Austrian School of economic thought holds that value is not intrinsic to any asset. Instead, the value of a given thing is subjective and situational. That is, it depends on what people need or want and can afford at that moment. But utility — what the thing can do — is intrinsic and objective. A hammer is always a hammer, and can always pound nails. But whether it is valuable to a given person at a specific moment depends on whether it meets their immediate needs. One person’s junk is indeed another person’s treasure.


These characteristics place gold among the world’s most eternal substances. It can rest for centuries at the bottom of the ocean or buried in desert sands or a backyard without tarnishing or eroding. And because it is almost exclusively a monetary metal, it doesn’t disappear after use. In contrast to base metals, very little gold is used in industry, and when it is, much of it recycled and reused because of its high value.


Note that in dollar terms oil is way up, while in gold terms it is remarkably stable over more than 6 decades. The correct conclusion is that oil isn’t getting more expensive; rather, the dollar is losing purchasing power. Gold cuts through the haze of monetary debasement to give a clear picture of value over time.


And since fiat currencies have no physical reality and depend for their value on the perceive integrity of the governments that create and manage them, image is everything and looking bad is deadly.


In March, Dutch bank ABN Amro informed customers who had stored gold bullion in its vaults that they could no longer have their gold back on demand, in effect defaulting on the storage agreement.


Most of the world’s approximately $100% of liquid wealth is overseen by mutual funds, hedge funds, insurance companies, sovereign wealth funds and pension funds. And they own virtually no gold.


Gold is primarily money, while silver, despite its long monetary history, is today principally an industrial metal with a growing number of uses.


If gold and silver are money, then they are not investments. An investment is something that, if successful, generates cash flow and potentially capital gains, but if less successful can produce a capital loss. Money, in contrast, is capital. It is what you receive when you sell an investment. It does not generate cash flow and does not “work” for you the way an investment does. But sound money does preserve existing wealth by maintaining its purchasing power over long periods of time.


Gold looks volatile when it is measured in fiat currencies — but those currencies are themselves extremely volatile. So variations in the gold / dollar exchange rate are actually fluctuations in the value of the dollar, not of gold.


Gold is not something one analyzes like a stock or bond, because standard investment techniques require future cash flows to calculate a present value. Instead, gold is simply where you park the portion of your capital — your money — until you are ready to spend it, invest it or save for the long haul.


Legal tender laws mandate that dollars be treated as interchangeable, but not all banks are the same. Some have riskier assets than others, meaning that dollars on deposit in a bank with top quality assets are inherently safer than those on deposit in a weaker bank.


Warren Buffett defines investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power in the future.”


The attraction of steady, automatic plan is that when prices are low, the same amount of currency buys more metal, and when prices are high it buys less.


In a fiat currency world, where money is just bits stored in or flowing between databases and backed by nothing but promises, waging a currency war is technically quite easy. A central bank clerk just types in a number stating how much government debt his organization is buying and hits send, and voila, the requisite amount of new dollars are created and added to the banking system.


Staying a half-step ahead of a wrathful market means being early to apprehend ideas the crowd finds ridiculous today but will obvious in retrospect.


3K years ago, Plato argued that the best form of government is one in which a “philosopher king” employs absolute power to create and maintain a just society. Today, this yearning for a combination of strength and wisdom at the top is as acute as ever. A strong leader gets things done, so according to this line of thought the key to success is to find the right person and turn them loose to make the system work.

But history has shown the philosopher king to be one of those intriguing ideals that, when attempted in the real world, always and everywhere falls prey to human nature. Power corrupts. Good, well-meaning leaders become demagogues who put pride and ideas of “legacy” above the welfare of citizens. Demagogues become corrupt, feathering their own nests by looting their subjects’ wealth. And corrupt leaders become tyrants, responding to opposition with force and turning their subjects into slaves. Initially-enlightened governments, in short, will devolve into dictatorships if allowed to.


When they met in Philadelphia in 1787 to create “a more perfect Union” of sovereign states, their guiding principal was the polar opposite of Plato’s: Because individuals are infinitely corruptible, governmental power should be strictly limited. They divided the federal government into 3 branches, delegated only 17 specific, defined power to it, and left all other powers to the states or to the people. The hope was that each component would use its authority to keep the others in check.