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Why your money is worth nothing

By David Scott | Monday 16 April 2018


 


Paper currency has led to the collapse of almost every economy that has tried to use a fiat (paper-based money backed by nothing) currency to trade for goods and services and it is not looking too good for the current attempt.

Throughout all of history, attempts at using fiat (paper money) currency has failed. When governments print fiat money that isn’t backed by any value, difficulty inevitably ensues. It often takes decades, but the results are always the same. Currently our all knowing and wise Governments, together with central Bankers are ignoring the long history of failed fiat currency, which is then used for the base of a fractional reserve banking system. That is for every £1 you place in your safe bank, the Bank will then lend it out up to 23 times. But if this one pound is lost, as the lender cannot afford to repay it (bad debt), then the bank needs to call back the other £22 (this is what the credit crunch was all about). In addition to this issue, your money is probably on instant access and it will have been lent to a borrower on a longer term time scale, creating a time mismatch. This is why a run on a bank is so dangerous. A bank cannot get its hands on their customers money immediately to pay the original depositors on demand, as it is probably have been used to fund a mortgage or some other longer committed time frame. When the Bank cannot pay out its depositors, it goes bust.

In truth under a fractional reserve banking system like the one we currently have our banks are always in a perpetual state of insolvency, as their liabilities are always more than their assets, it is just confidence in the system (not unlike with paper money) that stops them from going bust. Without being able to pay depositors their money back when it is demanded the bank fails and must be rescued – this is what a banking crisis is and it is why RBS had to be bailed out with taxpayer’s money and is currently a Nationalised Bank. We the tax payer still own 73% of it, bought at £5.02. Currently they are £2.64. The Bank of England, who can print money out of nowhere, cannot go bust and so it guarantees the deposits held in RBS with its balance sheet of nothingness.

 

At the start of the first century, the Roman Denarius was a coin containing approximately 94 percent real silver. By the end of the century, the amount of silver was reduced to 85 percent. Devaluing the denarius meant Nero and succeeding emperors could pay off their bills more easily while becoming richer. A hundred years later, the denarius contained less than 50 percent silver, and in 244 A.D., Emperor Philip the Arab devalued the currency down to 0.05 percent silver content. By the time the Roman empire collapsed, the denarius was made of 0.02 percent silver, and it became useless as a currency.

Copper backed China’s initial paper currency. When copper became scarce, China began to make iron coins. The iron currency became over issued and soon became devalued. By the 11th century, a Szechuan bank issued another paper currency that could be exchanged for valuable goods such as rare metals or silk. Continuous war with neighbouring Mongols caused economic inflation. China lost the war to Genghis Khan, who was too busy with other conquests to take much interest in China. Genghis’ grandson Kublai brought China and its finances under Mongolian control. Kublai used fiat currency for the vast China trade, including trade with Marco Polo. Kublai simply continued to print vast amounts of money as he continued his marauding and conquering. But infusing the economy with worthless monopoly money ruined many and chaos became the norm.

In Europe France has had the most interesting history with paper money and it may be the only country to face economic collapse not once, not twice, but three times by flooding the country with fiat currency. Spend thrift Sun King Louis XIV left a debt of 3 billion livres for his successor to deal with. Louis XV desperately needed incoming tax payments and demanded these be paid in paper currency. Predictably, the paper currency was quickly overprinted and became worthless. In the 18th century, France began another attempt at printing paper currency called assignats. By the end of the century, the assignat suffered 13,000 percent inflation. Napoleon rode to the rescue by instituting the gold franc, which stabilized France’s erratic currency. One would think the French might have seen a connection between the stable economy and gold-backed currency. France reverted to paper currency in the 1930s, the paper franc. In just more than a decade, the fiat franc became devalued by 99 percent. France’s third attempt at printing worthless monopoly paper money proved to be a dismal failure.

Following WWI, Germany’s Weimar Republic faced historic debts. So, Germany put the printing presses to work and the mark became more than worthless. So much so it was even used to heat furnaces, because burning the paper money to keep warm was more efficient than using it for trade.

Throughout the 20th century, many other countries flooded their economy with fiat currency – and collapsed as a result. The direct correlation between government interference with money and the devaluation of currency seems to escape many but is clearly evidenced.

 

In the new America the Colonies happily jumped on the fiat currency bandwagon and began flooding the new land with their own paper money. When these currencies quickly became over issued, they became devalued. Like the marc to come a few centuries later, colonial currency made for excellent form of warmth. The Revolutionary War was financed with a paper currency called the continental and this crashed on a grand scale. This brought about a healthy American distrust for fiat currency. So, the new US dollar was now backed by actual gold and the constitution says only gold and silver can be used as money, but like gun control where guns can "only be used in a well organised militia", this has been ignored and interpreted to suite the political needs of the time.

In 1913 the Federal Reserve was created, and the Currency once again fell under the aegis of government control and manipulation. In 1933, President Roosevelt made ownership of gold illegal and the close bond between the US dollar and the country’s gold reserves were severed gradually until President Nixon eliminated the gold standard entirely in 1971. The once mighty US dollar instantly turned into fiat currency. This was then followed by a decade of disastrous inflation.

So now we see the US following the historical well-worn path of paper money, with the government having printed trillions of dollars to pay off its record debt. Whilst in the short term it has stopped printing, the Europeans and Japanese have continued to print money with complete abandonment. Most worryingly the Swiss have become the cheer leader of all this recklessness, so much so that they have bought $80m worth of direct US shares, with freshly printed money. They have turned thin air in to real equity in the likes of Apple Inc.

 

There is no escaping history. Paper money and out-of-control national debts have always devalued the currency and ultimately caused massive inflation. The roadmap to a financial trouble was printed thousands of years ago, but overall the world seems to have forgotten this. Those nations buying all the Gold they can get their hands on, China, Russia and India seem at least to be giving a nodding acknowledgement to that whilst history does not repeat itself it does have rhymes.

For me Gold is Insurance. The one lesson that history has taught us is that mankind does not learn from history. With this backdrop do you not think that you should have some physical gold, especially in your pension? - for insurance purposes if nothing else. As the great J P Morgan said to US legislators, Gold is money, everything else is merely credit.

David Scott is an Investment Manager & Market Commentator at Andrews Gwynne


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