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

Global demand is again falling as credit contracts, a sign that debt-driven deflation is back but, today, there is an additional danger as well. Since 1971, because of the U.S. default on its gold obligations, money no longer possesses intrinsic value and the consequences will soon become apparent. Deflationary depressions and a collapse in the value of fiat money have happened before but never simultaneously. Soon, they will.

The Day of Reckoning Has Arrived
We are in what Stephen Roach, Chairman of Morgan Stanley Asia, calls the end-game, the resolution of past monetary excesses and imbalances, excesses and imbalances that reached never-before-seen heights in the last decade.

The Problem
Capitalism cannot function unless its constantly compounding debt is serviced and/or paid down. Today, the U.S., the world’s largest debtor, can no longer pay what it owes except by rolling its debt forward and borrowing more [in] what the late economist Hyman Minsky called ponzi-financing, financing common in the final stages of mature capital systems.

The amount of outstanding U.S. debt, according to Martin D. Weiss, www.moneyandmarkets.com, has now reached levels that can never be paid off. The United States government and its agencies have, by far,
- the largest pile-up of interest-bearing debts ($15.6 trillion),
- the largest accumulation of unsecured obligations (over $60 trillion),
- the largest yearly deficit ($1.6 trillion), and
- the greatest indebtedness to the rest of the world ($4.8 trillion).

The unpayable levels of U.S. debt are not just the problem of the U.S. because the U.S. dollar is the lynchpin of today’s fiat money system, U.S. debt is everyone’s problem. The U.S. dollar is the world reserve currency and a default by the U.S. will have far-reaching consequences, especially in China, its largest creditor.

The Solution
Bill Gross, co-founder of PIMCO, the world’s largest bond fund and an expert in matters of debt, wrote in 2006 that the way a reserve currency nation [such as the US] gets out from under the burden of excessive liabilities is to inflate, devalue, and tax.

a) Inflate
Inflation destroys the value/cost of liabilities by eroding the value of money. Debts are paid back with inflated currencies, a process which benefits the debtor and injures the creditor. This is why reserve currency nations usually inflate their way out of debt by printing what they owe.

b) Devalue
Devaluation is another option afforded reserve currency nations. By devaluing the value of their currency, the value of what they owe falls relative to other currencies. Again, the benefit is to the debtor at the expense of the creditor.

c) Tax
Taxation is another option but is no longer available to the U.S., as its liabilities are now too high. It would be like forcing the elderly and morbidly obese to engage in strenuous exercise to regain youth. Of the three, inflating away debt is by far the preferred option but it is one the U.S. can no longer choose.

Why Inflation Won’t Work
It’s tempting to think that the U.S. can inflate its way out of its fiscal problems. A faster, sustained increase in prices would erode the real value of past debt, and higher future inflation would – other things equal – reduce the real resources needed to service and pay back the promises we are making today. However, inflating away U.S. debt won’t work because as Richard Berner points out nearly half of federal outlays are [now] linked to inflation, meaning that increments to debt would [also] rise with inflation.

Inducing monetary inflation would also raise aggregate U.S. debt resulting in a self-defeating cycle of higher prices and higher debt. However, there is also another more fundamental reason why inflating away U.S. debt won’t work, to wit: Inflation is almost impossible to induce during severe deflationary contractions. Fed Chairman Ben Bernanke understands this difficulty quite well. Bernanke’s late mentor, Milton Friedman, theorized the Great Depression could have been prevented by sufficient monetary stimulus and so in 2008, faced with the possibility of another deflationary depression, Bernanke put Friedman’s theory to the test. Unfortunately, when tested, Friedman’s theory didn’t work. Despite Bernanke’s massive monetary expansion, global credit is still contracting and lending is drying up.

Inflating away debt is virtually impossible in the presence of deflation, but if U.S. monetary expansion is sufficiently large, it could result in the hyperinflation of the U.S. money supply, which would destroy both U.S. debt and the U.S. economy as well.

Managing Director and Chief U.S. Economist at Morgan Stanley, Richard Berner, recently discussed the reasons in We Can’t Inflate Our Way Out, February 24, 2010. www.morganstanley.com/views/gef/index.html#anchor6647bf63-2073-11df-978b-bbc960980e46

Will Devaluing The U.S. Dollar Work?
Devaluation is the U.S.’ only remaining option but, as pointed out in Comstock Partners’ special report of February 25th, “The Cycle of Deflation, Impediments to Debt Relief”, the major impediment to a U.S. devaluation to reduce debt is China saying:
“There is a stumbling block to the normal competitive devaluations that typically take place. In the past, a country that incurred too much debt just did what they could to devalue their currency in order to export their way out of the dilemma by exporting their goods and services to their trading partners…[but] the Chinese have linked their currency to ours, so as we debase our currency, one of our major trading partner’s currency is also declining and China becomes the major beneficiary of the debasement of our dollar.”

The China peg to the U.S. dollar thus prevents the U.S. from altering its trade deficit by currency devaluation, but it does not prevent the U.S. from devaluing the dollar for other reasons. If the U.S. does devalue the dollar, it will not be to reduce debt—it will be to maintain its advantage over the world in general and China in particular.

The Influence of China On U.S. Actions
U.S. dominance is being challenged by China. While it is not possible to know what the U.S. will do, it is naïve to believe the U.S. will do nothing; but whatever happens, U.S. debt and the U.S. dollar will be affected.

China has now significantly reduced its buying of U.S. debt leaving the U.S. with growing deficits and a virtual boycott by China of new U.S. IOUs. This will impact future U.S./China relations. The tentative but mutual benefits of the past are being replaced by self-interest as U.S. spending and consequent debt is increasingly perceived as being out of control by China. That perception is correct. Since the 1980s, America’s focus has been on borrowing more, not spending less and the implications are clear.

With China moving away from increasingly risky U.S. debt, the U.S. is now far more likely to treat China as a challenger than as a needed creditor and, while devaluing the U.S. dollar would have minimal impact on overall U.S. debt, it would have a significant impact on China. In December 2009, total foreign holdings of U.S. government debt equaled $3.29 trillion. With total U.S. obligations now close to $100 trillion, a 30 % devaluation of the U.S. dollar would impact only that debt held by foreigners. China currently owns at least $1.7 billion in U.S. dollar denominated securities and, if the U.S. devalued the dollar by 30 %, China’s losses on its investments would be in excess of $500 million.

As stated earlier, it is not possible to know what the U.S. will do but since WWII geopolitical considerations have always outweighed economic factors in U.S. policy decisions and there is little reason to expect this to change—even as the end-game approaches.

The End Game and Sovereign Default
The U.S. is trapped. Caught between rising expenditures and the need to borrow more, outstanding U.S. debt is incapable of ever being repaid and should the credit rating of the U.S. ever reflect its actual state, sovereign default, not devaluation would be the result.

In 2008, Kenneth Rogoff and Carmen Reinhart, in their book “This Time Is Different: A Panoramic View of Eight Centuries of Financial Crisis,” reviewed the history of sovereign defaults concluding that the then dearth of defaults was in actuality a warning of more to come. They were right.

As the end-game progresses it is impossible to know what the U.S. will do. It is likely the U.S. doesn’t know itself. What the U.S. does know is that it is now trapped by increasing levels of mounting debt from which there is no easy exit.

*http://beforeitsnews.com/story/21/656/Will_the_US_Devalue_the_Dollar.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.
- Sign up to receive every article posted via Twitter, Facebook, RSS feed or our Weekly Newsletter.

See larger image This Time Is Different: Eight Centuries of Financial Folly (Hardcover) By (author) Carmen M. Reinhart, Kenneth Rogoff List Price: $35.00 USD New From: $19.49 In Stock Used from: $18.00 In Stock

In further edited excerpts from the original article* Nick Barisheff (www.bmgbullion.com) goes on to say:

Currency versus Money
Most investors confuse money and currency, but they are not the same thing.

a) Money is defined as a medium of exchange, a unit of account and a store of value. For centuries, money referred to coins made of rare metals (gold and silver) with intrinsic value, and to notes backed by precious metals.

b) Currency, while it is a medium of exchange, is not a store of value. It only derives its value by arbitrary fiat government decree and hence the term “fiat currency”. Paper banknotes represent money but they are not money. They are simply promissory notes whose long-term “value” or purchasing power depends entirely on the fiscal and monetary discipline of the government that issued them.

Therein lies the problem. In an era of massive fiat currency expansion by profligate governments across the globe, today’s currencies are depreciating in value faster than yesterday’s news. Fortunately for precious metals investors, gold and precious metals have risen in value, and will continue to rise in value against all currencies because they have once again resumed their historical role as stores of value: money.

“When the price of gold moves, gold’s price isn’t moving; rather it is the value of the currencies in which it’s priced that is changing.” – John Tamny, economist, H.C. Wainwright Economics

The Decline of the World’s Currencies
Currency debasement isn’t a recent phenomenon. For decades, governments around the world, through their central banks, have been creating money out of thin air to cover their excessive spending and mounting debt. Investors have for the most part accepted this subtle form of taxation, because it seemed to have little personal impact. However, appearances are deceiving. Investors are discovering that the value of their dollar-denominated assets has actually declined a staggering 82 percent since 1971!

The Wrong Measuring Stick
Every day, the media (via currency traders) informs Canadian investors about the latest price of the Canadian dollar in US dollar terms, while US investors compare the US dollar to a basket of the world’s major currencies [the U.S. Dollar Index]. This information, however, gives investors surprisingly little insight into the true value of their portfolios. If we started measuring the world’s currencies against money (i.e., gold), investors would be horrified at the stark decline in the value of all currencies. Most investors’ portfolios are heavily weighted towards currency-denominated financial assets (stocks and bonds), but few realize that the true value or purchasing power of their portfolios is declining every single year because of currency depreciation.

The Rate of Currency Decline is Accelerating
Since 1913 (the year the US Federal Reserve was established), the US dollar has lost over 95 percent of its value of which 82 percent of its value has been just since since 1971 so the rate of currency decline is accelerating.

In the past ten years alone, the US dollar, the Canadian dollar, the UK pound and the euro have collectively fallen 70 percent in value if measured in real (currency-debased) terms. In other words, when they are priced in terms of gold.

The (Fiat Currency) Money Supply
Not too long ago, all the world’s major currencies were backed by gold because it was a universally recognized store of value. The gold standard imposed fiscal and monetary discipline, since each country had to hold enough gold to equal the amount of money in circulation however that is not the case any longer. Government spending around the world is exploding, and (fiat currency) money supply, along with government debt in the world’s major economies, is exploding along with it. Nowhere in the world has spending become more out of control than the US where the monetary response to last year’s financial crisis is creating yet another bubble, and this time it will be the bubble to end all bubbles.

Countries are Increasingly at Risk of Sovereign Debt Default
“In the process of saving a few ‘too big to fail’ corporations and their bond holders, policymakers are greatly increasing the risk of sovereign defaults.” – Puru Saxena, editor/publisher, Money Matters

The risk of massive and widespread sovereign debt default has never been higher. “Official” US government debt has soared to 90 percent of GDP, while multi-trillion-dollar budget deficits for the next several years will send that number soaring. Japan, the world’s second-largest economy, was recently put on credit watch. Its debt is twice total GDP, yet its newly elected government has announced much higher spending for 2010. The UK’s 2009 budget deficit will be over 14 percent of GDP, adding to a net debt that will reach 56 percent of GDP this year, 65 percent in 2010 and 78 percent by 2015.

Spain, Italy and Portugal are facing major fiscal deficits, as is Eastern Europe. Dubai is billions in debt and its prize jewel, Dubai World, is bankrupt. Greece’s credit rating has been slashed, and its debt is forecast to reach 130 percent of GDP. Then there is Iceland, whose debt had exploded to seven times GDP before the global meltdown. The country’s banking system has now collapsed, its currency is deeply devalued, its real estate market has imploded and the country is in a full-blown economic depression.

The Incredible Shrinking Dollar
As the world’s reserve currency, the US dollar is a proxy for the rest of the world’s currencies. The dollar’s decline is a direct reflection of America’s deepening financial troubles, exacerbated by a ravaged banking system that, by 2010, may see over one thousand banks insolvent. In 2009, the US incurred a budget deficit of $1.4 trillion, and its debt rose by $1.9 trillion due to off-budget expenditures. These off-budget expenditures alone were more than the 2008 budget deficit. At the end of 2009, America’s total debt was over 100 percent of GDP.

In their attempt to reflate the bubble-driven economy, President Barack Obama, Fed Chairman Ben Bernanke and Treasury Secretary Tim Geithner have decided to add to this financial house of cards. Instead of raising taxes or cutting expenditures, they have decided to borrow their way out of the problem and have the Fed create money out of thin air, which will almost certainly create another bubble. This bubble will make the others pale by comparison and will help destroy the US dollar. The dollar may be the world’s reserve currency, but China and other countries are not only questioning its status, but also actively campaigning for greater use of alternative currencies.

Gold Bullion Holding Strong
Where are most investors putting their cash? It should no longer be in stocks. Key stock indices like the Dow Jones Industrial Average have been flat to negative in nominal terms since the end of the last century but if the Dow is priced in gold (in other words, money) as opposed to depreciating dollars (in other words, fiat currency), its decline is far more dramatic. The Dow:Gold Ratio is not only in a downtrend, the downtrend is steepening which is a continuing indicator to move from equities to bullion.

Global creditors who currently hold trillions of dollars’ worth of dollar-denominated financial assets are dumping them to preserve their wealth. That is why gold bullion, along with its precious metals cousins, silver and platinum bullion, have been consistently keeping their value against financial assets.

Central Banks are Buying Gold Bullion
“We have a market-friendly Fed injecting a lot of liquidity in the system which will set us up for another bubble economy. Excessive monetary accommodation just takes us from bubble to bubble to bubble.” – Stephen Roach, chief economist, Morgan Stanley

India recently bought 200 metric tonnes of gold bullion from the International Monetary Fund for $6.7 billion. Russia has recently added 120 tonnes of bullion to its reserves, while China has steadily (and surreptitiously) increased its gold bullion reserves from 600 tonnes in 2003 to 1,054 tonnes today. China is even urging its people to put five percent of their savings into gold and silver because it is so worried about the dollar. Because trillions of dollars of its reserves remain in US dollar-denominated assets, China’s central bank will be diversifying into gold for many years to come.

The world’s central banks know that gold is primarily a monetary asset, not a commodity. That’s why a growing number of them are quietly diversifying out of US dollars and adding to their 29,000 tonnes of gold reserves.

In its 2010 Precious Metals Outlook, Scotiabank noted that “seeing the value of the dollar steadily erode must be a nightmare for large US creditors such as China, Japan, South Korea, Russia, the oil producing countries and Sovereign Wealth Funds (SWF)…

Major Investors are Diversifying into Gold
“Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that.” – Lou Jiwei, Chairman, China Investment Corporation

It is not just governments that are dumping dollars for bullion:
- A rapidly growing number of sovereign wealth funds (including China Investment Corporation) are participating, as are major institutional investors.
- Hedge fund manager John Paulson, who made $3 billion in 2008 by shorting subprime mortgages, recently took a multi-billion-dollar position in gold as a hedge against inflation.
- Northwestern Mutual Life Co.’s CEO Edward Zore said his company purchased $400 million in gold (the first time in its 152-year history) because “the downside risk is limited, but the upside is large. We have stocks in our portfolio that lost 95 percent. Gold is not going down to $90.”
- Hedge fund manager David Einhorn, through his Greenlight Capital fund, has sold gold ETFs in order to invest in longer-term and lower-risk gold bullion because of current US economic policy.
- Lone Pine Capital significantly increased its stake in gold this year.

Perhaps of even greater interest to the unwary investor is a survey of US hedge fund managers by London-based Moonraker Fund Management: 90 percent (20 of the 22) of the hedge fund managers surveyed admitted they had bought physical gold for personal investment. These sophisticated investors know something that the average investor doesn’t: that the global policy response to the financial crisis will not only devalue the world’s major currencies, it will decimate the US dollar.

Many Investors Still View Gold as a Commodity
Individual investors are not so farsighted – yet. Because most of them have only experienced one kind of market – a 25-year bull market in stocks – many still think gold is just a commodity like copper, zinc or pork bellies. Gold is far more than that, however. It has a 3,000 year history as money. For much of that time, it was the universal medium of exchange because of its divisibility, portability, rarity, beauty, malleability and indestructibility. Despite today’s negative sentiment, gold is not a speculation or a barbaric relic. Gold is money. Gold retains its purchasing power year after year.

Forty years ago it took 66 ounces of gold to buy a compact car. Today it takes only 14 ounces. If you had put your money in gold instead of dollars, the same car would actually be 79 percent cheaper, because gold keeps its value. Houses, stocks and virtually every other asset on earth would also be cheaper if bought with physical gold.

The more investors learn about bullion, the better for their portfolios If you are already a bullion investor, now is the time to add to your portfolio. If you are new to investing in bullion, now is the time to start dollar-cost-averaging into bullion. I encourage investors to learn as much as they can about bullion and about the markets in general. A good place to begin is the Learning Centre section of our website (www.bmgbullion.com). It offers a comprehensive look at the economy, money, markets and bullion investing, and provides a variety of thought-provoking articles written by experts in the field of gold and precious metals.

Gold is Money
Gold is money because it cannot be created out of thin air by government decree. Unlike bonds, gold does not represent someone else’s liability and, unlike stocks, gold does not rely on someone else’s promise of performance. Gold is money because, unlike currencies, impatient monetary policymakers cannot change its value. The rising gold prices we have experienced for the last eight years do not signal a bull market in precious metals, but rather a vote of decreasing confidence in the future value of paper currencies.

Currency-denominated financial assets are a disaster waiting to happen. The current economic rebound is a mirage, being entirely dependent on something artificial and unsustainable: massive government spending. A new crisis is building out of unprecedented fiscal and monetary mismanagement. Fortunately, smart investors can protect their wealth from the coming storm. The true level of risk has not been priced into the markets.

The time to shelter your wealth from the storm is now. There is no safer investment on earth than bullion, because bullion is and always will be money.

*http://www.bullionbullscanada.com/index.php?option=com_myblog&show=gold-is-money-unlike-the-world-s-currencies-gold-retains-its-value.html&Itemid=116

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.
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