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Prophets of Gold – Part 5 – Hyper-active over hyper-inflation

Posted by Don McLenaghen on January 27, 2012

Last time we discussed how fractional reserve banking can inflate the amount of money in an economy…the prophets hate inflated money.

Old fears renewed

The underlying premise of the previous planks of the prophet’s gilded construct is the idea of inflation. This actually has two parts, first is the inability to buy stuff because it becomes too expensive (classic inflation) and the devaluation of fixed assets (depreciation).

Now, it is true that fiat currency can experience hyper-inflation. It happened in Germany, Zimbabwe and other places…surprisingly a lot of ‘small’ nations have experienced hyper-inflations with little long-term detriments. The normal course of action is for a ‘revaluation’ of the currency. This has the harmful effect of wiping out ‘old money’; however for the majority of the populations (at least of these countries) poverty minimized this loss. Fixed assets are also safe for once a revaluation occurs these assets (property) are valued at the new stable currency maintaining an equivalent value prior to the hyper-inflation. That is why; those who fear hyper-inflation the most and thus preach the stability of the gold standard are those with large ‘savings’…the 1% types…those who have little real assets and thus must defend their (ironically) paper fortunes.

I am not saying hyper-inflation is always a minor and temporary event in people lives. We have all seen the wheel-barrows of money Germans needed to buy a loaf of bread.  In Germany’s case, we did have a major economy hitting the wall where simple revaluation did not seem to work. Of course Germany could not simply adopt a gold standard for most of its reserves were being paid out as reparations to ‘the victors of WW1’; it eventually recovered in small steps from 1923 to 1925. Germany did end up with a gold backed mark but this ‘saviour’ became the gate way to the depression for Germany less than 5 years later.

Why did it become the gate way to depression? The one thing the prophets of the gold standard mention the most is the one thing that is the biggest asset of ‘fiat money’ – the ability of the government to control the economy. Most prophets have an extreme fear of governments and thus see anything they do as innately wrong and to be eliminated or minimized. One of the realities of the capitalist system is the boom/bust cycle. The prophets believe that the gold standard will ensure stability by prevent the government from interfering in the ‘free market’; that historically gold has had a stable price and thus countries on the gold standard do not experience (large) boom or bust cycles. Historically this is pure fantasy.

Gold-flation, the instability of Gold

Whenever a government NEEDED money, it would just drop the gold standard, print what it needed and then return to the standard when it was convenient. The prophets have an existential fear of government and somehow think that the gold standard will miraculously prevent them from interfering in the national monetary system; this too has been proven to be pure fantasy. The USA alone has been effectively on and off the gold standard three times.

Using the USA, as an example, they have experienced dozens of recessions/depressions during the 19th century. Most were quite severe because under a fixed currency there is no way for the government to ‘push back’ against the economic tsunami that ‘bust’ begets. As everyone starts to suffer, spending goes down, leading to drops in demand, businesses close or go bankrupt leading to more suffering and even less spending…what is needed is ‘push back’ to restore economic equilibrium; this is when fiat money becomes a necessity. Let us remember that is was the USA’s attempt (and Germany and others) to maintain the gold standard that pushed a recession into the worst depression in modern times. That when a government was freed from the demands of the gold standard only then could they stimulate their economy by ‘printing money’; only then did the depression end. As mentioned earlier, a direct correlation between abandoning the gold standard and recovery can be found[1].

Governments can both stimulate economies, in a measured and controlled way, by increasing debt via the printing of money. This stimulus creates jobs, which creates demand, which creates more jobs. As the cost of goods rise, so too do wages. When an economy becomes ‘too hot’, the government reduces spending, pulls money out of the economy via increasing taxes (which should be used to reduce the debt incurred during the stimulus phase) there will be less money in the economy, meaning less will be bought, things will become more expensive, even less will be bought and the economy gently slows down. The role of the Bank of Canada, the Federal Reserve or any central bank is to balance the money supply to ensure limited and sustainable grown while avoiding boom or bust; for the last 80yrs it has worked well. Not perfect I admit but it has done well to smooth out the peaks and valleys of the capitalist system.

Now this does require some fiscal responsibility for governments to not go overboard, however it is in the long-term interest of governments to resist; the memory of Weimar Germany shows how quickly an undisciplined printing press can lead to ruin. Lessons learnt by the major economies as can be witnessed that since the 1930’s no major depression has occurred, no major currency had experienced hyper-inflation. One of the ways that has helped prevent ‘abuse’ by politicians is that in most (all?) modern governments, there is a separation between the government and the central bank. In Canada, the Bank of Canada is technically part of the government but is administered at arm’s length by an independent governor; the same is more evident in the USA were the Federal Reserve[2] is a private entity governed by presidential appointees

Now, you might say “what about now? The USA’s credit rating has been downgraded, Greece et al are about to default on loans, the Euro is about to crash! What about that?” Nothing to do with the gold standard but before we move on to these sexy issues lets deal with the other way inflation frightens the prophets of gold.

As mentioned there are two aspects to inflation; we have covered the supply/demand for currency and how it affects boom/bust cycles; the other is how long-term inflation can erode the value of fixed assets. In a world of ever increasing inequality, depreciation of assets is very important to the 1% (to single them out again). Inflation not only makes things more expensive but it also has the effect of eroding the value of fixed assets like property, savings, or overseas investments. If you buy a house for $100,000 at time X then sell it for 150,000 at time Y, you might think you have made 50,000; however if you factor in inflation of let’s say 10%, you only made 40,000…if its high inflation of 100% from time X to Y, you actually lost 50,000. That is why prophets of the gold standard, who constantly preach stability, have a vested interest in ensuring inflation is as close to zero as possible. The gold standard protects there ‘paper profits’ and zero inflation protects their luxury homes…their ‘comfort profits’. Now, I understand that a lot of the 99% have accepted the mantra put forward by the prophets; I am not saying that all those who want the gold standard are the 1%, but I would argue they have been duped by them. The myth of the gold standard is simple and convenient; the prophets promise in one simple move we can solve all our nation’s problems…who would not be tempted by that.

[1] Bernanke, Ben (March 2, 2004). “Remarks by Governor Ben S. Bernanke: Money, Gold and the Great Depression”. At the H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, Virginia

[2] The Fed, although governed by publicly appointed governors, is private banks. It’s in their vested interest to ensure the government does not induce major, let alone hyper, inflation. They would lose the value of their primary asset – money.


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