The debt ceiling deal agreement [is only going to exacerbate America's financial and economic woes and accelerate the demise of the U.S.] Dollar Standard which is inherently flawed and increasingly unstable. Its demise is imminent. The only question is will it be death by fire—hyperinflation—or death by ice—deflation? [Let me explain how the collapse of the dollar could well unfold.] Words: 944

Richard Duncan presents below excerpts* taken from his book, The Dollar Crisis, Chapter 20: Bernankeism, which was written in December 2004 to remind his readers what is coming down the pike that much more assuredly as a result of the recent debt ceiling agreement.He could have written a new article but there was absolutely no need to do so as the following excerpts from his book read as though they were just written yesterday! Duncan’s comments are presented below by Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), in a further edited ([  ]), abridged (…) and reformatted manner for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. Duncan’s chosen excerpts are as follows:

It is almost certain that policymakers will respond to the approaching crisis by applying the two great economic policy tools of the last century: Keynesianism and Monetarism. The abuse of those tools will prolong and exacerbate the death throes of the Dollar Standard.

The first recourse will be to employ more fiscal stimulus. With prices falling and in light of the extraordinary amount of paper money that has been created in recent years, interest rates will be very low and there will be little difficulty in paying interest on a much larger amount of government debt. It would not be surprising to see the U.S. budget deficit surpass $1 trillion by 2007 or 2008 if the U.S. current account deficit has come down significantly by that time.

If, at that point, the U.S. current account deficit has been reduced, foreign central banks would not have a sufficient inflow of dollars to finance such a large deterioration in the U.S. budget deficit, even assuming that Fannie and Freddie have ceased issuing any new, competing, debt of their own.

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The Fed, however, as Governor Bernanke explained, has already put considerable thought into how to deal with such a contingency and stands ready, in Bernanke’s opinion, to support “a broad-based tax cut” through “a program of open-market purchases to alleviate any tendency for interest rates to rise”.

How long could such “cooperation between the monetary and fiscal authorities” underpin the global economy? For quite a number of years most probably. Economic trends play themselves out over very long periods of time. Moreover, US policymakers will use every last tool at their disposal to prevent, or, at least, delay a global depression. An economic system underpinned by large-scale fiscal stimulus financed by central bank monetization of government debt could hardly be described as capitalism (perhaps the term Bernankeism would be appropriate) but, with any luck, it could stave off disaster for a considerable length of time.

Nevertheless, despite the best efforts of policymakers to keep the Dollar Standard alive and to stave off the depression that would most probably follow its collapse, ultimately, one of the following scenarios is likely to overwhelm even Bernankeism.

1. A protectionist backlash against free trade, resulting in a trade war similar to that which occurred during the Great Depression.
2. A US asset price bubble (as interest rates fall toward zero), that drives property prices so high that they can’t be financed even at very low interest rates. This is similar to what occurred in Japan at the end of the 1980s.
3. A meltdown of the $200 trillion derivatives market. $200 trillion is roughly six times global GDP.
4. A  loss of nerve by policy makers that deters them from undertaking ever more unorthodox economic policies, resulting in a “deer in the headlights” kind of policy freeze.
5. A decline in interest rates to 0% or very near 0% as in Japan at present.

Any one of the first four scenarios could undermine the Dollar Standard, but the final scenario, where interest rates fall very near 0%, would certainly deal it a fatal blow. From that point, the only option left to stimulate aggregate demand would be to drop paper money from helicopters. That too would fail, however, for who would accept paper dropped from helicopters in exchange for real goods and services?

Hyperinflation would quickly set in. Economic transactions would then be conducted through barter rather than via the medium of a debased script.

A gold standard would eventually re-emerge.

A “Deer In The Headlights” Policy Freeze?

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Editor’s Note:

• The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
• Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above

The current economic crisis through which the United States is passing has given a heightened awareness to the country’s national debt:

The government’s deficit spending that cumulatively has been increasing the national debt has made the United States that much poorer than it otherwise could have and would have been had the dollar value of these real resources not been siphoned off and out of use in the productive private sectors of the American economy. What has made this less visible and less obvious to the American citizenry is precisely because it has been financed through government borrowing rather than government taxation.

Deficit spending easily creates the illusion that something can be had for nothing. The government borrows “today” and can provide “benefits” to various groups in the society in the present with the appearance of no immediate “cost” or “burden” upon the citizenry. Yet, whether acquired by taxing or borrowing, the resulting total government expenditures represent the real resources and the private sector consumption or investment spending those resources could have financed that must be foregone. There are no “free lunches,” as it has often been pointed out, and that applies to both what government borrows as much as what it more directly taxes to cover its outlays.

What makes deficit spending an attractive “path of least resistance” in the political process is precisely the fact that it enables deferring the decision of telling voter constituents by how much taxes would otherwise have to be increased, and upon whom they would fall, in the “here and now” to generate the additional revenue to pay for the spending that is financed through borrowing. As the recent fiscal problems in a number of member nations of the European Union have highlighted, [however,] eventually there are limits to how far a government can try to hide or defer the real costs of all that it is providing or promising through its total expenditures to various voter constituent groups. Standard & Poor’s recent decision to downgrade the U.S. government’s prospective credit rating to “negative” shows clearly that what is happening in parts of Europe can happen here.

Given current projections by the Congressional Budget Office, the deficits are projected to continue indefinitely into future years and decade, with the cumulative national debt nearly doubling from its present level. In addition, whether covered by taxes or deficit financing, these debt estimates do not include the federal government’s unfunded liabilities for Social Security and Medicare through most of the 21st century. In 2009, the Social Security and Medicare trust funds were estimated to have legal commitments under existing law for expenditures equal to at least $43 trillion over the next seventy-five years. Others have projected this unfunded liability of the United States government to be much higher – possibly over $100 trillion.

The Federal Reserve and the Economic Crisis

The responsibility for a good part of the current economic crisis must be put at the doorstep of America’s central bank, the Federal Reserve. By some measures of the money supply, the monetary aggregates (MZM or M-2) grew by fifty percent or more between 2003 and 2007. This massive flooding of the financial markets with huge amounts of liquidity provided the funds that fed the mortgage, investment, and consumer debt bubbles in the first decade of this century. Interest rates were pushed far below any historical levels.

For a good part of those five years, according to the St. Louis Federal Reserve Bank, the federal funds rate (the rate of interest at which banks lend to each other), when adjusted for inflation – the “real rate” – was either negative or well below two percent. In other words, the Federal Reserve supplied so much money to the banking sector that banks were lending money to each other for free for a good part of this time. It is no wonder that related market interest rates were also pushed way down during this period.

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Market interest rates are supposed to tell the truth. Like any other price on the market, interest rates are suppose to balance the decision of income earners to save a portion of their income with the desire of others to borrow that savings for various investment and other purposes. In addition, the rates of interest, through the present value factor, are meant to limit investment time horizons undertaken within the available savings to successfully bring the investments to completion and sustainability in the longer-term.

Due to the Fed’s policy, interest rates were not allowed to do their “job” in the market place. Indeed, Fed policy made interest rates tell “lies.” The Federal Reserve’s “easy money” policy made it appear, in terms of the cost of borrowing, that there was more than enough real resources in the economy for spending and borrowing to meet everyone’s consumer, investment and government deficit needs far in excess of the economy’s actual productive capacity.

The housing bubble was indicative of this. To attract people to take out loans, banks not only lowered interest rates (and therefore the cost of borrowing), they also lowered their standards for credit worthiness. To get the money, somehow, out the door, financial institutions found “creative” ways to bundle together mortgage loans into tradable packages that they could then pass on to other investors. It seemed to minimize the risk from issuing all those sub-prime home loans, which we now see were really the housing market’s version of high-risk junk bonds. The fears were soothed by the fact that housing prices kept climbing as home buyers pushed them higher and higher with all of that newly created Federal Reserve money.

At the same time, government-created home-insurance agencies like Fannie Mae and Freddie Mac were guaranteeing a growing number of these wobbly mortgages, with the assurance that the “full faith and credit” of Uncle Same stood behind them. By the time the Federal government formally had to take over complete control of Fannie and Freddie in 2008, they were holding the guarantees for half of the $10 trillion American housing market.

Low interest rates and reduced credit standards were also feeding a huge consumer-spending boom that resulted in a 25 percent increase in consumer debt between 2003 and 2008, from $2 trillion to over $2.5 trillion. With interest rates so low, there was little incentive to save for tomorrow and big incentives to borrow and consume today. But, according to the U.S. Census Bureau, during this five-year period average real income only increased by at the most 2 percent. Peoples’ debt burdens, therefore, rose dramatically.

The easy money and government-guaranteed house of cards all started to come tumbling down in the second half of 2008. The Federal Reserve’s response was to open wide the monetary spigots even more than before the bubbles burst.

The Federal Reserve has dramatically increased its balance sheet by expanding its holding of U.S. government securities and private-sector mortgage-back securities to the tune of around $2.3 trillion. Traditional Open Market Operations plus its aggressive “quantitative easing” policy have increased bank reserves from $94.1 billion in 2007 to $1.3 trillion by April 2011, for a near fourteen-fold increase, and the monetary basis in general has expanded from $850.5 billion in 2007 to $2,242.9 trillion in April of 2011, for a 260 percent increase. The monetary aggregates, MZM and M-2, respectively, have grown by 28 percent and 21.6 percent over this same period.

In the name of supposedly preventing a possible price deflation in the aftermath of the economic boom, Fed policy has delayed and retarded the economy from effectively re-adjusting and re-coordinating the sectoral imbalances and distortions that had been generated during the bubble years. Once again interest rates have been kept artificially low. In real terms, the federal funds rate and the 1-year Treasury yield have been in the negative range since the last quarter of 2009 and, at the current time, is estimated to be below minus two percent [which] has prevented interest rates from informing market transactors what the real savings conditions are in the economy. So, once again, the availability of savings and the real cost of borrowing is difficult to discern so as to make reasonable and rational investment decisions, and not to foster a new wave of misdirected and unsustainable private sector investment and financial decisions.

The housing market has not been allowed to fully adjust, either. With so much of the mortgage-backed securities being held off the market in the portfolio of the Federal Reserve, there is little way to determine any real market-based pricing to determine their worth or their total availability so the housing market can finally bottom out with clearer information of supply and demand conditions for a sustainable recovery. This misguided Fed policy has been, in my view, a primary factor behind the slow and sluggish recovery of the United States economy out of the current recession.

Federal Reserve Policy and Monetizing the Debt

Many times in history, governments have used their power over the monetary printing press to create the funds needed to cover their expenses in excess of taxes collected,… that is, they have monetized the debt].

Monetizing the debt refers to the creation of new money to finance all or a portion of the government’s borrowing. Since the early 2008 to the present, Federal Reserve holdings of U.S. Treasuries have increased by about 240 percent, from $591 billion in March 2008 to $1.4 trillion in early May 2011, or a nearly $1 trillion increase. In the face of an additional $3.6 trillion in accumulated debt during the last three fiscal years, it might seem that Fed policy has “monetized” less than one-third of government borrowing during this period.

The Fed’s purchase of mortgage-backed securities, however – no less than its purchase of U.S. Treasuries – increases the amount of reserves in the banking system available for lending and since 2008 the Federal Reserve had bought an amount of mortgaged-backed securities that it prices on its balance sheet as being equal about $928 billion.

The $1.4 trillion increase in the monetary base since the end of 2007, from $850.5 billion to $2.2 trillion, has increased MZM measurement of the money supply by $2,161.1, or an additional $769 billion dollars in the economy above the increase in the monetary base. This is an amount that is 83 percent of the dollar value of the $927 billions in mortgage-backed securities.

Due to the “money multiplier” effect – that under fractional reserves, total new bank loans are potentially a multiple of the additional reserves injected into the banking system – it is not necessary for the Fed to purchase, dollar-for-dollar, every additional dollar of government borrowing to generate a total increase in the money supply that may be equal to the government’s deficit. Thus, it can be argued that Fed monetary policy has succeeded, in fact, in generating an increase in the amount of money in the banking system that is equal to two-thirds of the government’s $3.6 trillion of new accumulated debt.

That the money multiplier effect has not been as great as it might have been, so far, is because the Federal Reserve has been paying interest to member banks to not lend their excess reserves. This sluggishness in potential lending has also been affected by the general “regime uncertainty” that continues to pervade the economy. This uncertainty concerns the future direction of government monetary and fiscal policy. In an economic climate in which it [is] difficult to anticipate the future tax structure, the likely magnitude of future government borrowing, and the impact of new government programs, hesitancy exists on the part of both borrowers and lenders to take on new commitments. [Nevertheless,] the monetary expansion has most certainly has been the factor behind the worsening problem of rising prices in the U.S. economy and the significant fall in the value of the dollar on the foreign exchange markets.

The National Debt and Monetary Policy

It is hard for Americans to think of their own country experiencing the same type of fiscal crisis that has periodically occurred in “third world” countries. That type of government financial mismanagement is supposed to only happen in what used to be called “banana republics” but the fact is, the U.S. is following a course of fiscal irresponsibility that may lead to highly undesirable consequences. The bottom line truth is that over the decades the government – under both Republican and Democratic leadership – has promised the American people, through a wide range of redistributive and transfer programs and other on-going budgetary commitments, more than the U.S. economy can successfully deliver without seriously damaging the country’s capacity to produce and grow through the rest of this century.

 To try to continue to borrow our way out of this dilemma would be just more of the same on the road to ruin. The real resources to pay for all the governmental largess that has been promised would have to come out of either significantly higher taxes or crowding out more and more private sector access to investment funds to cover continuing budget deficits. Whether from domestic or foreign lenders, the cost of borrowing will eventually and inescapably rise. There is only so much savings in the world to fund private investment and government borrowing, particularly in a world in which developing countries are intensely trying to catch up with the industrialized nations.

Interest rates on government borrowing will rise, both because of the scarcity of the savings to go around and lenders’ concerns about America’s ability to tax enough in the future to pay back what has been borrowed. Default risk premiums need not only apply to countries like Greece.

Reliance on the Federal Reserve to “print our way” out of the dilemma through more monetary expansion is not and cannot be an answer, either. Printing paper money or creating it on computer screens at the Federal Reserve does not produce real resources. It does not increase the supply of labor or capital – the machines, tools, and equipment – out of which desired goods and services can be manufactured and provided. That only comes from work, savings and investment. Not from more green pieces of paper with presidents’ faces on them.

However, what inflation can do is:

1. Accelerate the devaluation of the dollar  on the foreign exchange markets, and thereby disrupting trading patterns and investment flows between the U.S. and the rest of the world;
2. Reduce the value, or purchasing power, of every dollar in people’s pockets throughout the economy as prices start to rise higher and higher;
3. Undermine the effectiveness of the price system to assist consumers/producers make rational market decisions, due to the uneven manner in which inflation impacts of some prices first and effects others only later;
4. Potentially slow down capital formation or even generate capital consumption, as inflation’s uneven effects on prices makes it difficult to calculate profit from loss;
5. Distort interest rates in financial markets, creating an imbalance between savings and investment that sets in motion the boom and bust of the business cycle;
6. Create incentives for people to waste their time and resources trying to find ways to hedge against inflation, rather than devote their efforts in more productive ways that improve standards of living over time;
7. Bring about social tensions as people look for scapegoats to blame for the disruptive and damaging effects of inflation, rather than see its source in Federal Reserve monetary policy;
8. Risk political pressures to introduce distorting price and wage controls or foreign exchange regulations to fight the symptom of rising prices, rather than the source of the problem – monetary expansion.

What is To Be Done?

The bottom line is [that] government is too big. It spends too much, taxes too heavily, and borrows too much. For a long time, the country has been trending more and more in the direction of increasing political paternalism. Some people argue, when it is proposed to reduce the size and scope of government in our society, that this is breaking some supposed “social contract” between government and “the people” but the only workable “social contract” for a free society is the one outlined by the American Founding Fathers in the Declaration of Independence and formalized in the Constitution of the United States.

The reform agenda for deficit and debt reduction must start from the premise that all men are created equal, with governmental privileges and favors for none, and which expects government to respect and secure each individual’s right to his life, liberty, and honestly acquired property and have as its target a radical “downsizing” of government. That policy should plan to reduce government spending across the board in every line item of the federal budget by 10 to 15 percent each year until government has been reduced in size and scope to a level and a degree that resembles, once again, the Founding Father’s conception of a free and limited government.

A first step in this fiscal reform is to not increase the national debt limit. The government should begin, now, living within its means – that is, the taxes currently collected by the Treasury. In spite of some of the rhetoric in the media, the U.S. need not run the risk of defaulting or losing its international financial credit rating. Any and all interest payments or maturing debt can be paid for out of tax receipts. What will have to be reduced are other expenditures of the government but the required reductions and cuts in various existing programs should be considered as the necessary “wake-up call” for everyone in America that we have been living far beyond our means. As we begin living within those means, priorities will have to be made and trade-offs will have to be accepted as part of the transition to a smaller and more constitutionally limited government.

In addition, the power of monetary discretion must be taken out of the hands of the Federal Reserve. The fact is, central banking is a form of monetary central planning under which it is left in the hands of the members of the Board of Governors of the Federal Reserve to “plan” the quantity of money in the economy, influence the value or purchasing power of the monetary unit, and manipulate interest rates in the loan markets. The monetary central planners who run the Federal Reserve have no more or greater knowledge, wisdom or ability that those central planners in the old Soviet Union. The periodic recurrence of the boom and bust of the business cycle demonstrates that there is no way for them to get it right – in spite of them saying, again and again, that “next time” they will get it right…

The goal should be to move towards a market-based monetary system, the first step in such an institutional change being a commodity-backed monetary order such as a gold standard and in the longer-run serious consideration must be given the possibilities of a monetary system completely privatized and competitive, without government control, management, or supervision.

The budgetary and fiscal crisis right now has made many political issues far clearer in people’s minds. The debt dilemma is a challenge and an opportunity to set America on a freer and potentially more prosperous track, if the reality of the situation is looked at foursquare in the eye. Otherwise, dangerous, destabilizing, and damaging monetary and fiscal times may be ahead.

*http://www.thedailybell.com/2306/Richard-Ebeling-Monetary-Policy-the-Federal-Reserve-and-the-National-Debt-Problem.html

Editor’s Note:

• The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
• Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.

What’s The Plan For The Dollar?

Those in the U.S. power structure know what the plan is if the U.S. dollar should fail. They are not admitting publically that there is even the remotest chance that it could happen but, rest assured, there is a plan.  There is always a plan.  To paraphrase Franklin Roosevelt, nothing happens by chance in government, so don’t be caught up in such a ‘surprise’ event – whatever it may be and whenever it occurs. Words: 1345

So say Jerry Western and Lorimer Wilson (www.FinancialArticleSummariesToday.com)  going on to explain:

The U.S. Dollar: Too Much of a Good Thing?

The U.S. dollar really is everyone’s problem.  There are more dollars in circulation worldwide than any other currency – perhaps more than all other currencies combined as a full two-thirds of the rest of the world’s foreign reserves are denominated in the U.S. dollar.  It’s also true that two-thirds of all dollars circulate outside of the United States.  They have long been the choice of exchange on the world’s black markets.  The reason is because they are so recognizable and accepted everywhere else; in other words, liquid and fungible.  They have also tended to keep their purchasing power value relatively constant until recently.  That’s why many nations peg their currency to the dollar.  It also helps that it is still the world reserve currency.

Is the Decline of the U.S. Dollar Just A Matter of Time?

The above virtues being touted there are too many of them anymore and the law of supply and demand states that the more of something there is, the less value it has and the less demand there is for it.  The world is becoming saturated with the U.S. dollar and many are looking for alternatives. As such, it is only a matter of time before the dollar does fail.   When, how, and at what speed are all that are left for debate.

What Would the Decline of the U.S. Dollar Mean For America – and the World?

Failure of the dollar would be noticeable in many ways and when it does fail we won’t have to ask if it has - we’ll know.  Failure of the dollar will mean many things.  It will mean that it is no longer recognized as having or retaining value.  In other words, confidence in the dollar will be greatly or entirely diminished.  We only hold dollars (or any currency), not because they have value themselves, and not that we find them useful, but because the perception that others will accept them for goods or services.  We hold them because we have confidence that we will be able to pass them on at a later date.

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A failure of the U.S. dollar would mean that, at a minimum, the cost of everything, but especially anything we import, would rise dramatically.  In a worst case scenario, the dollar would not be accepted in any quantity for goods or services, either domestic or foreign.

What Would Some of the Possible Triggers Be For a Decline in the U.S. Dollar?

1. The Chinese could start selling their U.S. Bonds and Treasuries. 

This would make interest rates rise, collapse demand for new offerings, and make dollars return to the U.S., thus stoking domestic inflation.

2. The dollar could suddenly or gradually stop being the world reserve currency. 

This would cause the value of the dollar on the Forex (currency market) to fall against other currencies, possibly setting off a self-fulfilling hyper- inflationary event.

3. Another currency could become backed by gold before the dollar.

This would set off a scramble to convert dollars into that currency and causing the dollar to fail as people try to get rid of them to buy the other currency.

The above are just a few of the possible scenarios that could precipitate the failure of the dollar.  The important point is that this failure is not only possible but likely, and likely to happen sooner rather than later.

How Could the Demise of the U.S. Dollar Be Avoided?

1. We could collectively start living within our means.

This would stop the debasement of the dollar but such an effort would be politically and socially unacceptable to both the government and the people.

2. The U.S. could implement a new currency.

The problem with such a ‘solution’ is that the problem wouldn’t go away by simply erasing zeros on the currency or introducing a new name for the dollar.  The inflation dynamic would still be present if no other action were taken in conjunction with such action.

3. The Fed could hyper-inflate the economy.

Such an effort would only be a temporary solution and not a cure, however.  The U.S. Government has already caused a bubble in the Dollar, Bond, and Treasury markets.  The bailout schemes of the last few years necessitated that trillions of new dollars be created.  This is the path we have been on for some time and it has masked the problem to a certain extent but this ‘solution’ would by no means be a cure.

4. The U.S. government could default on its debt obligations.

Heck, the U.S. already defaulted on its internal obligations in 1933 and to its external creditors in 1971.  The U.S. continues in default every day by issuing more dollars than can ever be redeemed at their current purchasing power.  It is the chosen path, the inflation path.  The question, however, is whether the U.S. would default en-masse on all of its remaining obligations all at one time?  If so, it would be a moon shot for gold, silver and all commodities immediately following the default.  This would likely be done at the most advantageous time (night, holiday) for the government and the worst time for you, leaving you without time to prepare or protect yourself.

5. The Fed could revalue the U.S. dollar in terms of gold.

This is already happening gradually and goes hand-in-hand with the previous two scenarios.  In this scenario, instead of the U.S. defaulting on its obligations or re-valuing the currency, it could re-value the price of gold in dollars announcing that it would pay (buy) a certain (higher) price for gold on the open market.  This would have the effect of immediately re-valuing every ounce of gold on the planet.  It would then be possible to cover our outstanding debt with our gold reserves (if they’re all there), leading to a de-facto gold standard.

6. Return to a Gold Standard.

This seems to be inevitable at some point.  How we get there and the ultimate price established for an ounce of gold are up for debate.  In all likelihood, plans are already afoot and this will be a ‘surprising’ event for most when, not if, but when it does happen.

7. A combination of the above.

This is also very likely. The price of gold will simply be allowed to rise to clear the market.  They revalued gold with the stroke of a pen in the 1930′s and could very well do it again.  All that needs to be done is for the government to state that it will now purchase gold for a set dollar amount and then all gold, everywhere, would be worth that amount.  Like an equity trading on a stock market, it’s the last trade at the margin that sets the value of every other stock of the company.

Conclusion

Someone, somewhere, in the U.S. power structure knows what the plan is for the dollar but isn’t telling us – but rest assured – there is a plan.  There is always a plan.  To paraphrase Franklin Roosevelt, nothing happens by chance in government.  Don’t be caught up in such a ‘surprise’ event – whatever it may be and whenever it occurs. Please take note:

Holding physical gold is your lifeline when the U.S. dollar fails.

Understanding the Old Gold Standard Basics

The 18th century gold standard system that so many people view as a free market alternative to central banks determining credit conditions, money supply, etc., was not really a free market. The system was dependent on the central bank, in this case the Bank of England and later the U.S. Government, offering to buy all gold tendered to it at a price established by the government. Moreover, that price had to be far above any foreseeable market clearing price. If it was less than any foreseeable market clearing price the banking system could not accumulate the gold stocks necessary for the system to work. If the price was too low private individuals would see it as a one way bet to accumulate gold stocks, much as they did in the 1960s.

The Effect Of the Old Gold Standard Price On the Great Depression

Many economists believe that the supply of gold at the price of $21/oz. was too low and that this, together with the French and the U.S. holding too large a share of the gold stocks, was the fundamental driving force behind the 1929-33 world wide depression. Yes, Bernanke blamed the depression on the central banks, but they were just following the rules the gold system imposed on them. The depression ended in each advanced countries soon after each left the gold standard. Moreover, Roosevelt did much to end the depression when he arbitrarily raised the price of gold to $35, increasing the world supply of gold by two-thirds.

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In the 1960s the problems of an inadequate supply of gold reemerged and Nixon solved the problem by [having] the price of gold free to be set by the market. In 1969 there were no significant central bank purchases or sales of gold so the 1969 price of around $39 probably was a good market clearing price that balanced the supply of gold and the non-monetary demand for gold.

What the Real Price of Gold Should Be These Days

Of course in a free market there is no reason for the price to remain stable and in the early 1970s I conducted a major study of the supply and non-monetary demand for gold –industrial, jewelery and hoarding–… [and concluded that,] given the price elasticities of demand and supply, to balance the supply and non-monetary demand for gold the real price of gold would have to rise at a 3% to 5% annual rate. Since then many things have impacted gold markets including the Russians selling their gold stocks, other central banks selling gold, technological improvements in gold mining, Japanese stagnation, India legalizing private gold holdings and gold imports and the emergence of China as a major market. [However,] had the real price of gold risen since 1969 at a 3% annual rate that would [have generated] a current price of some $900 and if the trend growth rate had been 5% the current price would be about $2,225 as compared to the current market price of [marginally less than] $1400.

Conclusion

Given the trends outlined above I would conclude that to re-establish a new gold exchange standard probably would require a gold price of about $5,000. [That being said,] I wonder if any of those talking about re-establishing a gold standard have thought about the implications of [such a new price level for gold]? If people are scared of the inflationary impact of QE2, [it begs the question:]

What would re-establishing a $5,000 gold standard mean for inflation?

*http://www.angrybearblog.com/2010/11/gold-standard.html

Should Gold be the Market’s Global Currency?
 

World Bank president Robert Zoellick has stirred up a hornet’s nest with his recent call for a return to a gold anchor in the global financial system. The usual suspects immediately denounced him – Keynesian Brad DeLong has [gone so far as to] anoint Zoellick the “Stupidest Man Alive” –  [and I would like to add my voice to the chorus by explaining] the dangers of Zoellick’s gold proposal, and why fans of the classical gold standard should be wary. Words: 1708

So says Robert P. Murphy (mises.org) in his article* which Lorimer Wilson, editor of www.munKNEE.com, has reformatted into edited [...] excerpts below for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.) Murphy goes on to say:

The Limitations of the Printing Press

In order to make sense of our current situation — and why Zoellick would timidly call for a return to a pseudo-gold standard — we need to first think through the logic of fiat money. Fiat money is not “backed up” by anything; it is intrinsically useless paper (or nowadays, mere electronic bookkeeping entries) that is valuable only because of its anticipated purchasing power. In contrast, a market-based commodity money, such as gold or silver, is a useful good in its own right, serving industrial and consumer purposes.

The critical difference between fiat and commodity money is that fiat money can be produced in virtually unlimited quantities at very low cost. In this respect, the person who controls the printing press of a fiat currency is in a much stronger position than the person who owns a gold mine. With just some ink and paper, the printing press can create a million new dollars quite easily, whereas the owner of the gold mine would need to hire workers to operate expensive equipment in order to bring forth new amounts of gold having the same market value.

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We shouldn’t conclude, [however,] that the owner of a printing press has unlimited power. For one thing, prices would eventually rise in response to large amounts of new money creation. So printing off, say, $1 million in fresh new currency would buy fewer and fewer goods and services with each successive round of inflation. Even more problematic [is that] the people in the community would abandon the currency if inflation became too excessive. For example, if a brilliant counterfeiter developed a machine to produce perfect $100 bills in his basement, he wouldn’t be able to literally buy the whole world. Long before that point — even if the authorities didn’t track him down — people would have ditched the dollar and switched to the use of other currencies.

Although the above scenario sounds far-fetched, it is actually very close to the real world right now. The only difference is that instead of our hypothetical, brilliant counterfeiter in the basement, we have our actual, less-than-brilliant economist in the Federal Reserve. His name, of course, is Ben Bernanke.

The Bretton Woods System

The original Bretton Woods system — so named because of the location of the meetings that established it in 1944 — governed international monetary arrangements in the post-war era until Richard Nixon’s fateful decision to close the gold window in 1971.

Under the Bretton Woods agreement, other nations would use U.S. dollars as their “reserves.” The Bank of England, Bank of France, etc., would issue their own domestic currencies, but would maintain stockpiles of U.S. dollars with which they could regulate the value of their own currencies. If the British pound sterling began to depreciate against the U.S. dollar, for example, then the Bank of England could enter the foreign-exchange market and use some of its dollar holdings to “buy pounds,” thus bringing the value of the pound back within target. In this way investors across the globe could feel comfortable with their British financial holdings because the pound was tied to the dollar.

Note the tremendously advantageous position that the Bretton Woods system assigned to the United States. As issuer of the world’s reserve currency, the United States had a very captive market. If the Bank of England wanted to increase its dollar reserves by another $1 million, then ultimately Great Britain had to sell $1 million worth of goods and services to Americans in order to earn the dollars. The Bretton Woods system effectively expanded the scope for U.S. inflation to the entire world, thus magnifying the benefits to those who controlled the American printing press.

Of course, the other members of Bretton Woods understood these details. The U.S. achieved its privileged outcome in the negotiations because of its economic and military might at that point in world history but in order to restrain the natural temptation for runaway inflation by U.S. officials, the Bretton Woods system linked the dollar itself to gold. Specifically, any central bank could redeem its dollars for gold at the fixed rate of $35 per ounce.

The Bretton Woods system has been described as a “gold-exchange standard,” in contrast to the classical gold standard. In the original framework — which was smashed, like so many other aspects of Western civilization, in World War I — each nation tied its own currency to gold. Then, the currencies in turn traded at fixed exchange rates against each other, because of their mutual ties to gold. Individual citizens could present the currencies for redemption in gold, keeping a very tight check on inflation. If any central bank began to issue too much currency in relation to its gold reserves, speculators would begin depleting the reserves, causing the central bank to quickly reverse course.

Under the diluted Bretton Woods system, individual citizens had no right of redemption. Most currencies were only indirectly linked to gold (via their link to the dollar) and, of course, even this tenuous link was destroyed when Richard Nixon abandoned the dollar’s convertibility to gold in 1971. At this point, the entire global financial system was based utterly on fiat money.

No longer shackled by the peg to gold, the Federal Reserve began printing money with reckless abandon. The obvious results were an acceleration in U.S. consumer prices, and an explosion in the U.S. trade deficit, trends that noticeably worsen after 1971.

The Reluctant Return to Gold

Say what you will about the powerful people running the global monetary system, but they aren’t stupid. They can see as well as the rest of us that there is no “exit strategy” for Bernanke’s bouts of massive inflation, or “quantitative easing” as they now call it. At some point, the trillion(s) in excess reserves will begin leaking back into the broader monetary aggregates. At that point  Bernanke or a successor will need to choose between saving the dollar or saving major Wall Street institutions. I predict that he will sacrifice the dollar, and it seems many elites around the world have come to the same conclusion.

It is in this context that World Bank president Zoellick writes:

The G20 should complement [a] growth recovery programme with a plan to build a co-operative monetary system that reflects emerging economic conditions. This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

(See http://www.munknee.com/2010/11/imf-proposing-new-world-currency-to-replace-u-s-dollar-and-other-national-currencies/ for more detailed commentary on the IMF’s proposals for a new world currency)

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today. (emphasis added)

“Gold is the bane of central bankers.”

To repeat, gold is the bane of central bankers; it ties their hands and limits their discretion when conducting monetary policy. However, the game collapses if people lose faith in the fiat currency underpinning the whole system. As the recklessness of Bernanke’s moves becomes apparent to more and more people, the central planners around the world will need to throw a bone to the fearful public. A “basket of currencies,” each of which is still fiat-paper money, will not suffice.

As Zoellick is a member of the Council on Foreign Relations, and a participant in the notorious Bilderberg meetings, some analysts are understandably suspicious of his motives. After all, if powerful people were trying to introduce a regional currency to replace the dollar — in the same way that the euro has supplanted the traditional European currencies — then it would be necessary to first wreck the dollar. In its place, it would be very tempting to offer a new currency with a tie to gold. In this light, what appear to be “inexplicable” and contradictory actions by the Federal Reserve and other powerful figures would make perfect sense.

Conclusion

Regardless of the machinations of the political insiders, the laws of economics cannot be denied. Central bankers cannot be trusted with the printing press, especially when there is no formal check on their inflationary policies.

It is no coincidence that gold is hitting such heights as investors the world over hunker down for what may very well be a collapse of the dollar system.

*http://mises.org/daily/4841 (Robert Murphy is an adjunct scholar of the Mises Institute, where he will be teaching “Anatomy of the Fed” at the Mises Academy this winter. He runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, and The Politically Incorrect Guide to the Great Depression and the New Deal.)

The U.S. economy is in an intensifying inflationary recession that eventually will evolve into a hyperinflationary great depression… [at which time] a $100 bill in the United States will become worth more as functional toilet paper/tissue than as currency. The U.S. government and Federal Reserve already have committed the system to this course through the easy politics of a bottomless pocketbook, the servicing of big-moneyed special interests, and gross mismanagement. Words: 3565

So says John Williams (www.shadowstats.com) in edited excerpts from his original article*.

 Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and www.munKNEE.com (Your Key to Making Money!) has edited ([ ]), abridged (…) and reformatted (some sub-titles and bold/italics emphases) the article below for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.

Williams goes on to say, in part:

There is No Way of Avoiding Financial Armageddon
The U.S. has no way of avoiding a financial Armageddon. Bankrupt sovereign states most commonly use the currency printing press as a solution to not having enough money to cover their obligations. The alternative would be for the U.S. to renege on its existing debt and obligations, a solution for modern sovereign states rarely seen outside of governments overthrown in revolution, and a solution with no happier ending than simply printing the needed money. With the creation of massive amounts of new fiat (not backed by gold) dollars will come the eventual complete collapse of the value of the U.S. dollar and related dollar-denominated paper assets. What lies ahead will be extremely difficult and unhappy times for many.

Defining the Components of a Hyperinflationary Great Depression

Deflation. A decrease in the prices of goods and services, usually tied to a contraction of money in circulation.

Inflation. An increase in the prices of goods and services, usually tied to an increase of money in circulation.

Hyperinflation: Extreme inflation, minimally in excess of four-digit annual percent change, where the involved currency becomes worthless.

7 to 10 Digit Inflation Forecast
The circumstance envisioned ahead is not one of double- or triple- digit annual inflation, but more along the lines of seven- to 10-digit inflation seen in other circumstances during the last century. Under such circumstances, the currency in question becomes worthless, as seen in Germany (Weimar Republic) in the early 1920s, in Hungary after World War II and in the dismembered Yugoslavia of the early 1990s.

Recession, Depression and Great Depression
Before World War II, all downturns simply were referred to as depressions. In the wake of the Great Depression of the 1930s, however, a euphemism was sought for future economic contractions so as to avoid evoking memories of that earlier, financially painful time.

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Accordingly, a post-World War II downturn was called “recession.” Officially, the worst post-World War II recession was from November 1973 through March 1975, with a peak-to-trough contraction of 5%.

Here are the definitions:
Recession:
Two or more consecutive quarters of contracting real (inflation-adjusted) GDP, where the downturn is not triggered by an exogenous factor such as a truckers’ strike.

Depression:
A recession, where the peak-to-trough contraction in real growth exceeds 10%.

Great Depression:
A depression, where the peak-to-trough contraction in real growth exceeds 25%.
On the basis of the preceding, there has been the one Great Depression, in the 1930s. Most of the economic contractions before that would be classified as depressions. All business downturns since World War II — as officially reported — have been recessions.

We are Halfway to Qualifying as a Depression
The current economic contraction is about halfway towards being classified as a “depression,” based on my definitions and GDP accounting. Net of gimmicked methodologies that have reduced CPI inflation reporting and inflated GDP reporting, the U.S. economy has been in a recession since late-2006 and the current outlook does not exclude further bounces and dips in economic activity. As was seen during the Great Depression, in severe contractions the economy can hit bottom and then bounce briefly until it falls again, finding a new bottom. The current downturn, by my numbers, already is halfway to qualifying as a depression.

The efforts by the federal government and the Federal Reserve to prevent a systemic collapse as a result of the banking solvency crisis has started to spike broad money growth and in response to the rapidly deteriorating fundamentals underlying the value of the U.S. dollar, selling of the greenback has been intense, but contained, with brief periods of stability. In the near future, dollar selling should build towards an extreme, with heavy foreign investment in the dollar fleeing the U.S. currency for safety elsewhere. With the domestic financial markets and U.S. Treasuries so heavily dependent on foreign capital for liquidity, the Federal Reserve will be forced increasingly to monetize federal debt. That process will build over time, given the federal government’s effective bankruptcy. Therein lies the ultimate basis for the pending hyperinflation.

Historical U.S. Inflation: Why Hyperinflation Instead of Deflation
What promises hyperinflation this time is the lack monetary discipline formerly imposed on the system by the gold standard, and a Federal Reserve dedicated to preventing a collapse in the money supply and the implosion of the still, extremely over-leveraged domestic financial system.

Aside from minor average annual price level declines in 1944 and 1955, the United States has not seen a deflationary period in consumer prices since before World War II. The reason for this is the same as to why there has not been a formal depression since before World War II: the abandonment of the gold standard and recognition by the Federal Reserve of the impact of monetary policy — free of gold-standard system restraints — on the economy.

The gold standard was a system that automatically imposed and maintained monetary discipline. Excesses in one period would be followed by a flight of gold from the system and a resulting contraction in the money supply, economic activity and prices.

Faced with the Great Depression, and unable to stimulate the economy, partially due to the monetary discipline imposed by the gold standard, Franklin Roosevelt used those issues as an excuse to abandon gold and to adopt close to a fully fiat currency under the auspices of what I call the debt standard, where the government effectively could print and spend whatever money it wanted to. (Sound familiar?)

Roosevelt’s actions were against the backdrop of the banking system being in a state of collapse. The Fed stood by twiddling its thumbs as banks failed and the money supply imploded. A depression collapsed into the Great Depression, with intensified price deflation. Importantly, a sharp decline in broad money supply is a prerequisite to goods and services price deflation.

Messrs Greenspan and Bernanke are students of the Great Depression period. As did Mr. Greenspan before him, “Helicopter Ben” has vowed not to allow a repeat of the 1930s money supply collapse. Attempting to counter concerns of another Great Depression-style deflation, Bernanke has explained:

“I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States …Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero. Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. However, the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” The full text of then-Fed Governor Bernanke’s remarks can be found at: http://federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm.

Where Franklin Roosevelt abandoned the gold standard and its financial discipline for the debt standard, eleven successive administrations have pushed the debt standard to the limits of its viability. The effect of these policies has been a slow-motion destruction of the U.S. dollar’s purchasing power since the gold standard was abandoned in 1933.

The U.S. Government Effectively is Bankrupt
As discussed in the next section, the limits to the unlimited abuse of the debt standard are particularly evident in the GAAP-based financial statements of the U.S. government, which show that, with no ability to honor their obligations, the government effectively is bankrupt.

At such debt levels, the markets soon will recoil from lending Uncle Sam whatever he needs. Major buyers of U.S. Treasuries from outside the United States, including a number of central banks, already are balking. These investors have funded nearly all net U.S. Treasury debt issuance of the last five years, putting to use the excess dollars flushed into the global markets by the United States’ excessive and ever-expanding trade deficit. This practice, however, generated liquidity for the U.S. markets that has helped to depress long-term Treasury yields as well as to boost equity prices, in general.

Although the U.S, government faces ultimate insolvency, it has the same way out taken by most countries faced with bankruptcy. It can print whatever money it needs to create in order to meet its obligations. The effect of such action is a runaway inflation — a hyperinflation — with a resulting, effective full debasement of the U.S. dollar, the world’s reserve currency. The magnitude of the loss of the U.S. dollar’s purchasing power in the last 75 years now has the potential of being replicated within a few days or weeks.

In the present environment, the chances for the collapse in money supply needed to generate a consumer price deflation are nil because:
1. the discipline of the gold standard that helped trigger historical deflations is gone.
2. both from the standpoint of the government’s fiscal irresponsibility and from the Fed’s standpoint of providing the financial system with whatever liquidity is needed to keep it afloat, the U.S. central bank already is pushing broad money growth to new extremes, not containing it.

The near-term outlook is … for extremely strong upside pressure on U.S. inflation. Accordingly, gold prices should continue moving higher, setting new historic highs (and more).

U.S. Government Cannot Cover Existing Obligations
The U.S. Treasury publishes annual financial statements of the United States Government, prepared using generally accepted accounting principles (GAAP), audited by the General Accountability Office (GAO) and signed off on by the Treasury Secretary.

These statements show that the federal government’s finances not only are out of control, but the actual deficit is not containable. Put into perspective, if the government were to raise taxes so as to seize 100% of all wages, salaries and corporate profits, it still would be showing an annual deficit using GAAP accounting on a consistent basis! In like manner, given current revenues, if it stopped spending every penny (including defense and homeland security) other than for Social Security and Medicare obligations, the government still would be showing an annual deficit!

Further, aside from a weakening economic outlook, if the annual deficit is beyond containment through standard fiscal actions, then the United States has no way to grow out of this shortfall.

The GAAP-accounting is what a U.S. corporation would have to show. The Administration’s rationale as to why Social Security and Medicare should remain off balance sheet runs along the lines that the government always has the option of changing the Social Security and Medicare programs. That said, there clearly is no one in political Washington willing to go public with the concept of eliminating or substantially cutting those programs.

Consider that given the current financial condition of the government, various politicians are pushing ever further for expensive cradle-to-grave programs for the electorate, ranging from national health insurance to bailouts of mortgaged homeowners at risk of foreclosure. With no full funding available for any new programs, the government again is showing its willingness to spend whatever money it has to create. The intent going forward is inflation — hyperinflation. This circumstance has evolved with the full knowledge of political Washington and the Federal Reserve.

U.S. Finances Look Like Those of a Banana Republic
Indeed, the U.S. federal obligations are so huge versus the national GDP that the country’s finances look more like those of a banana republic than the world’s premiere financial power and home to the world’s primary reserve currency, the U.S. dollar.

If not for the special position the United States holds in the world, its debt — U.S. Treasuries — likely would be rated as below investment grade, instead of triple-A. Moody’s has even hinted at a longer-term downgrade on Treasury securities. While a three-month Treasury bill should be safe, I would not want to bet on receiving full value on a 10-year Treasury note or 30-year Treasury bond.

Yet most U.S. Treasury issuance has been purchased by investors outside the United States. Not only will these investors been taking a hit in terms of the value of the U.S. dollar, but also they face meaningful default/devaluation risk in the future. It is only a matter of time before this accommodation of foreign investors shifts to flight to safety outside the greenback, and therein will develop the early pressures for the Fed to start becoming the lender of last resort to the federal government.

Depression/Great Depression
The U.S. economy is in a deepening structural change that has resulted from U.S. trade policies that have driven the U.S. manufacturing base offshore. As a result, a large number of related, high paying jobs have been lost to U.S. workers.

As the U.S. trade deficit has risen to the highest level for any country in history, U.S. average weekly earnings, adjusted for inflation, have fallen. Even using official CPI for deflation, current real earnings are below their peak back in the 1970s.

The effect of this structural change has been that most consumers have been unable to sustain adequate income growth beyond the rate of inflation and, as such, unable to maintain their standard of living. The only way that personal consumption — the dominant component of GDP — can grow in such a circumstance is for the consumer to take on new debt or to liquidate savings. Both those factors are short-lived and have reached untenable extremes. Debt expansion and savings liquidation both were encouraged by the investment bubbles created by Alan Greenspan; he knew that economic growth could not be had otherwise. Part of what is happening today is payback for those policies.

This circumstance places both the federal government and the Federal Reserve in untenable positions…it can neither stimulate the economy nor contain inflation. Lowering rates has done little to stimulate the structurally-impaired economy, and raising rates may become necessary in defense of the dollar. Similarly, raising rates will do little to contain a non-demand driven inflation.

By the time hyperinflation kicks in, the economy already should be in depression, and the hyperinflation quickly should pull the economy into a great depression. Uncontained inflation is likely to bring normal commercial activity to a halt.

Hyperinflationary Great Depression.
The current systemic bailout by the Federal Reserve and the U.S. government has made the circumstance worse. Pushing recent Treasury funding needs on foreign investors — stuck with excess dollars from the ever-expanding U.S. trade deficit — has created a huge dollar overhang in the markets that already has started to crumble. The more the crisis has been pushed into the future, the greater the potential for pending calamity has become.

Milton Friedman and Anna Jacobson Schwartz noted in their classic “A Monetary History of the United States” that the early stages of the Weimar Republic hyperinflation were accompanied by a huge influx of foreign capital … which, after initial benefit, helped to destabilize the system. “As the mark depreciated, foreigners at first were persuaded that it would subsequently appreciate and so bought a large volume of mark assets …” Such boosted the foreign exchange value of the German mark and the value of German assets. “As the German inflation went on, expectations were reversed, the inflow of capital was replaced by an outflow, and the mark depreciated more rapidly … (Friedman p. 76).”

The Weimar circumstance is closer to the current U.S. circumstance, although, in certain aspects, the current situation is worse. Today’s U.S. economy is languishing in the structural problems of the loss of its manufacturing base and a shift of domestic wealth offshore. In the early 1920s, foreign investors were not propping up the world’s reserve currency in an effort to prevent a global financial collapse, knowing in advance that they were doomed to take a large hit on their investments in Germany. In today’s environment, both central bank and major private investors know that the dollar is going to be a losing proposition. They either expect and/or hope that they can get out of the dollar in time to lock in their profits, or, primarily in the case of the central banks, that they can forestall the ultimate global economic crisis.

[Under such circumstances] the U.S. dollar would be open to the potentially of a rapid and massive decline, and dumping of U.S. Treasuries, that the Federal Reserve would be forced to monetize significant sums of Treasury debt, triggering the early phases of a monetary inflation. In this environment annual multi-trillion dollar deficits rapidly would feed into a vicious, self-feeding cycle of currency debasement and hyperinflation.

Lack of Physical Cash.
The United States in a hyperinflation would experience the quick disappearance of cash as we know it. Were there a future run on the U.S. dollar the biggest problem would be getting adequate cash to the depositors. As little as 1.5% of M3 is in circulation in the U.S with the rest of the dollars being used elsewhere. For the system to continue functioning in anything close to a normal manner, the government would have to produce rapidly an extraordinary amount of new cash, and electronic commerce would have to be able to adjust to rapidly changing prices. In terms of cash, new bills of much higher denominations would be needed, but production lead time is a problem. Conspiracy theories of recent years have suggested the U.S. Government already has printed a new currency of red-colored bills, intended for some dual internal and external U.S. dollar system. If such indeed were the case, then there might be a store of “new dollars” that could be released at a 1-to-1,000,000 ratio, or whatever ratio was needed to make the new currency meaningful, but such would not resolve any long-term problems, unless it were part of an overall restructuring of the domestic and global financial and currency systems. From a practical standpoint, currency would disappear, at least for a period of time in the early period of a hyperinflation.

With the vast bulk of today’s money not being physical, but electronic, however, chances of the system adapting here are virtually nil. Think of the time, work and effort that went into preparing computer systems for Y2K, or even problems with the recent early shift to daylight savings time. Systems would have to be adjusted for variable, rather than fixed pricing, credit card lines would need to be expanded daily, the number of digits used in tallying dollar-denominated transactions would need to be expanded sharply. From a practical standpoint, the electronic quasi-cashless society of today also would shut down early in a hyperinflation. Unfortunately, this circumstance rapidly would exacerbate an ongoing economic collapse.

With standard currency and electronic payment systems non-functional, commerce quickly would devolve into black markets for goods and services and a barter system.

Financial Hedges
During these times, safety and liquidity remain key concerns for investments, as investors look to preserve their assets and wealth through what are going to be the most difficult of times.

a) Gold and Silver
In such a circumstance, gold and silver would be primary hedging tools that would retain real value and also be portable in the event of possible civil turmoil. Also, at some point, the failure of the world’s primary reserve currency will lead to the structuring of a new global currency system. I would not be surprised to find gold as part of the new system, structured in there in an effort to sell the system to the public.

b) Real Estate
Real estate also would provide a basic hedge, but it lacks the portability and liquidity of gold.

c) Off-shore Investments
Having some funds invested offshore — outside of the U.S. dollar — would be a plus in circumstances where the government might impose currency or capital controls.

d) Equities
While equities do provide something of an inflation hedge — revenues and profits get expressed in current dollars — they also reflect underlying economic and political fundamentals. As such, I still look for U.S. stocks to take an ultimate 90% hit, peak-to-trough, net of inflation, during this period.

The current circumstance will evolve into a hyperinflationary depression, then great depression… by 2018.

*http://www.shadowstats.com/article/hyperinflation (“John Williams’ Shadow Government Statistics” is an electronic newsletter service that exposes and analyzes flaws in current U.S. government economic data and reporting, as well as in certain private-sector numbers, and provides an assessment of underlying economic and financial conditions, net of financial-market and political hype.)

Have you ever traveled abroad and taken a look at the local currency and wondered how the citizens of that country could take seriously what looks like “Monopoly money?” I’ve got news for you: you’re using the same stuff. Monopoly money is the money over which some government has a monopoly. It is the currency of the realm only because the state makes it illegal to use any other type. Words: 633

Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com, provides below further reformatted and edited [..] excerpts from Robert Prechter’s (www.elloittwave.com) original article* for the sake of clarity and brevity to ensure a fast and easy read. Prechter goes on to say:

Paper Money Is Doomed to Depreciate – Look at the USD
Promissory notes issued by a state and declared the only legal tender are always doomed to depreciate to worthlessness because of the natural incentives and forces associated with governments. A state cannot resist a method of confiscating assets, particularly one that is hidden from the view of most voters and subjects.

A State Sponsored Gold Standard is Only a Political Promise – Remember Nixon?
By extension, it is unreasonable to advocate a standard for such notes, which is simply a state’s promise that its currency will always be redeemable in a specific amount of something valuable, such as gold. A gold standard of this type is only as good as the political promises behind it, reducing its value to no more than that of paper.

It could be argued, in fact, that a state-sponsored gold standard is far more dangerous than none at all, as it imbues citizens with a false sense of security. Their long range plans are thus built upon an unreliable promise that the monetary measuring unit will remain stable. Later, when the government’s “IOU-something specific” becomes, as Colonel E.C. Harwood put it, “IOU nothing in particular,” reliability disappears and the arbitrary reigns. Although the populace tends to retain its confidence in the currency for awhile thereafter, the ultimate result is chaos.

Grams of Gold Are the Best Currency
The only sound monetary system is a voluntary one. The free market always chooses the best possible form, or forms, of money. To date, the market’s choice throughout the centuries, wherever a free market for money has existed, has been and remains precious metal. This preference will undoubtedly remain until a better form of money is discovered and chosen. Until then, prices for goods and services should be denominated not in state fictions such as dollars or yen or francs, but in specific weights of today’s preferred monetary metal, i.e., in grams of gold.

Gold is Not Something ‘To Buy and Hold Forever’
That being said, it is also true, and crucial to wise investing, that markets come in both “bull” and “bear” types. Being a “gold bug” at the wrong time can be very costly in currency terms. It is all well and good to despise fiat money, but it is hardly useful to sit in gold and silver as if no other opportunities exist.

In contrast to the one-note approach, which has had an immense opportunity cost since 1980, competent market analysis can help you make many timely and profitable financial decisions in all markets, including gold and silver.

*http://www.financialsense.com/Experts/ewave/2009/0612.html

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Periodically in history, the expansion of credit creates the illusion of prosperity which, regretfully, ends in the inevitable bust which seems to be the case today. The sheer magnitude of credit destruction occuring right now is depressionary. The return to growth will be a long and painful process. Words: 625

In further edited excerpts from the original article* Moses Kim (www.expected returns.net) goes on to say:

In a functioning gold standard, current account imbalances self-correct. However, in our fiat-based system – with the dollar as the reserve currency – current account deficits persist as foreigners use their acquired dollars to purchase Treasuries. This sterilization process holds inflation in check, while suppressing interest rates. Crudely, massive current account deficits serve to reinforce the creation of credit and perpetuate the historic debt bubble.

The Bubble is Deflating
Unfortunately, the bubble has started to deflate. To see how this depression will potentially play out, we will have to turn for guidance to:

a) The Great Depression saw an enormous expansion in credit that led to the debt driven “Roaring Twenties”. People were similarly under the illusion that a new era of prosperity was at hand, regardless of increasing debt obligations. The bubble eventually popped, and excessive margin on stocks led to the stock market collapse in 1929. Massive debt liquidation hindered economic growth for over a decade.

The current debt crisis dwarfs that of the Great Depression for many reasons. To begin, indebtedness is more widespread, spanning the government, consumer, and corporate sectors, whereas, during the Great Depression, debt was isolated to the government sector. The magnitude of debt is also greater. At the onset of the Great Depression, interest bearing debt was 170% of GDP; in 2008, total interest bearing debt reached 350% of GDP. This monumental debt burden doesn’t even take into account unregulated derivatives, which are perhaps the biggest threat to our financial system.

Warren Buffett called derivatives “weapons of financial mass destruction”, and indeed they are. The collapse of Lehman almost brought down our whole financial edifice. The truth is, Lehman was a small player in the derivatives game. Anyone who thinks the threat of systematic collapse has been averted is underestimating the potential effect of over 500 trillion dollars in derivatives imploding as counterparties default.

b) The “Lost Decade” in Japan provides another illustration of a collapsing debt bubble. The level of total household debt as a percentage of disposable income reached 130% prior to Japan’s collapse. U.S. households reached similar levels of indebtedness in 2008 before the start of the current crisis.

Using stocks as a means of comparison, we can expect a downturn in the Dow in line with the Nikkei’s 80% collapse. Although this may seem unfathomable, the Dow is certainly pointing to this possibility.

In addition the Japanese were saving at a rate of 11% when their debt bubble imploded, which left them in a relatively strong financial position. In contrast, our savings rate was close to 0% in 2007, with consumption playing a far greater role in our GDP growth. This suggests the retrenchment in our consumption, reflected by collapsing personal consumption expenditures, will have a tremendous negative impact on our GDP.

Economists and media pundits who are calling for an end to the “recession” this year plainly do not understand the nature of credit in our system. The sheer magnitude of credit destruction occuring right now is depressionary. The return to growth will be a long and painful process. Like all bubbles, the U.S. debt bubble is ending.

*http://expectedreturns.blogspot.com/2009/06/case-for-depression-part-2-credit.html (Expected Returns is a blog dedicated to a spin-free analysis of current economic events and the gold market.)

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