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THE
ROCKET SCHOOL OF ECONOMICS


Real Money, Funny Money and YOU -- Part 1.
by Professor von Braun

May 21st, 2005

Since 1932 the US dollar, currently the pre-eminent reserve currency of nearly all central banks, has been losing purchasing power, estimated by some as being as much as 95%. Or put another way, what cost a $1.00 in 1932 now needs $19.00 to acquire. From a purchasing power point of view it has already collapsed. During that 73 year period much has happened when it comes to financial markets, currencies, debt, taxes and the concept of wealth.

The actuality of a currency that was redeemable in gold and/or silver by the issuer of the paper notes is, of course, long gone. Ownership of gold by U.S. citizens was outlawed on April 5, 1933 when President Roosevelt issued an executive order "forbidding the hoarding of gold coin, gold bullion and gold certificates". This made it a felony to own the metal, punishable by a fine of up to $10,000 or 10 years imprisonment. Gold was handed in and the holders received $20.67 per ounce. President Roosevelt issued a proclamation under the Gold Reserve Act on January 31, 1934 permanently 'fixing' the price of gold at $35 per ounce, a substantial increase on the price paid to citizens, who had, several months earlier been forced to return their gold for a lesser price.

President Nixon's decision to activate the right given earlier by Congress and remove the US off an international gold standard on August 15, 1971 ended the convertibility of the dollar by foreign holders into gold and set free US central bankers to essentially issue as much paper as they thought necessary.

What is often overlooked is that, as of January 1, 1975, when private ownership by US citizens of gold was allowed, the U.S. dollar indirectly went back onto a gold standard, though that return was only partial due to legal tender laws. Nonetheless, the option for individual U.S. citizens to convert paper currency to physical metal and take delivery had, after 42 years, been restored. Obviously, as gold is priced in US dollars, the holders of these dollars now had the ability to convert them into a gold instrument, either coin or bullion and once again become "hoarders" if they so wished.

For several years after that date the 'price' of gold increased dramatically as commodity inflation ruled the day, culminating in January of 1980 in the mid $800's.

Since that time we have witnessed the expansion of financial markets to a degree never seen before. Asset inflation has been taking place at a very rapid rate, with the Federal Reserve printing 'money' -- essentially swapping paper for paper, IOU's for IOU's, creating the appearance of 'value' merely by inflating prices by creating more IOU's.

The perceived value of an individual's assets has of course risen dramatically during this period with hardly a market being missed out. Stock prices, house prices, gas prices, new car prices, art prices, meal prices, education prices, medical costs, etc, all have risen in either value or cost.

In fact the 'value' of these increased assets is not dissimilar from the decline in the purchasing power of the instrument used to denominate them. In other words, as the quoted price of something goes up it appears to be nearly the exact opposite of the decrease in the purchasing power of the instrument used to transact business. While the individual may have more of the 'units', effectively the purchasing power has decreased to the same degree that the value of the asset has increased.

After August 15, 1971, when, as previously mentioned, the US dollar was no longer convertible into gold, a decision that followed the ongoing redemption of large amounts of US $'s (IOU's) for bullion by the French, Italian, Dutch and German banking systems (from 1950 through to 1973 official US gold reserves decreased by 11,000 tonnes, most of which ended up in Europe) the US was now able to run what President de Gaulle's economic advisor, Jacques Rueff, had called the 'deficit without tears'.

In other words, a deficit could be maintained with no accountability since there no longer was anything to convert the dollars into other than to deposit them with US banks, which is where they came from. The recipients of these dollars were basically stuck with them and that is the situation today. The only way to maintain this rather neat trick is to continue to inflate assets via the creation of more paper ad infinitum. As long as the illusion of wealth in the form of rising asset prices is maintained via the process of re-inflation and every major central bank agrees to play the game, then obviously given the rise in value in recent years of assets denominated in dollars, it works very well.

It should come as no surprise that the gold market has been manipulated during this period. As the entire asset inflation game is a manipulation in its own right, designed to maintain the illusion of wealth while producing little of value, gold can not be excluded.

What is worthy of note is that the gold price today has also increased from 1932 by a factor similar to the decrease in the purchasing power of the dollar, about 20 fold actually, which suggests a constant at work here, albeit an often unrecognized one. When it comes to gold and currencies one could well ask the question, "which came first, the chicken or the egg?", Or perhaps, more precisely, it might be useful to ask "Which is the chicken and which is the egg?"

The convertibility ratio of the dollar into gold remains similar to what it was in the early 1930's from a purchasing power perspective, in spite of obvious attempts to remove it from the role as the benchmark by which all currencies are measured. Obviously there have been fluctuations in both the value of the dollar and the quoted price of gold, but gold, unlike paper currencies, can't become other than what it is.

The one big advantage it has is this simple fact: gold is gold and it never will be anything else. Gold is not a promise to pay a promise to pay. The value, when compared to the purchasing power of the dollar, has remained relatively constant for 72 years (since 1933 when gold ownership by an individual was illegal) and during the 34 years (since 1971 when the US went off the gold standard) that the now unconstrained US $ has been the financial world's pre-eminent reserve currency. Indeed, gold's value has been constant over millennia; a well known example being today's cost of a serviceable man's suit compared to a Roman outfitting expense; an ounce of gold.

Today citizens of the U.S., along, of course, with the rest of the world, have the ability to go neutral on the dollar and hold gold as a hedge against a collapsing or depreciating currency.

Recently there has been much chatter about the imminent collapse of the US dollar, as well as talk of other Central Banks diversifying their reserves into something other than US dollars. Warren Buffet has been short the dollar, as have other notable holders of US dollar denominated assets. These assets are of course the same ones that have risen in value as a result of the aggressive asset inflation scheme led by the Federal Reserve and now adopted by most Western nations. It should not be surprising that rising real estate prices are common to the countries involved, while stocks are, since 2000, a tad more subdued and not as volatile to the upside.

Real estate is of course the deadlier manipulation as there are more participants, home owners and would-be home owners, than there are participants in the stock market. They all need a roof over their heads, after all. It should not be a surprise that the current real estate boom follows the heady days of Nasdaq at 5000+, as the bankers needed something to keep the asset inflation game going and homeowners generally have reliable cashflow from income, although that, too, is getting pushed to the limit.

What is surprising is the idea that other Central Bank's can diversify into something other than the US dollar as a reserve, when the dollar already constitutes 70% of the reserves of all other Central Banks. What would they diversify into? By holding dollars they can't redeem, they, too, have been locked into the asset inflation game which has to continue for it to continue. The concept of going neutral on the dollar is not an alternative they have.

Could the Bank of Japan diversify? Could the ECB diversify? Diversify into what one has to ask -- since they are all holding US dollars as a large percentage of their reserves, who would buy them?

One answer I have heard from a well known dollar bear is that they would buy gold. From whom I asked? How could a Central Bank convert $100 Billion of reserves into gold, which even at today's prices equates to approximately 8000 tonnes of physical metal? It is an impossibility, since a) the metal is not available and b) who would be the buyers for the US dollars? If the US still has its reported 8000 tonnes of gold reserves, how could it, with gold at $420 an ounce, go back to redeeming dollars for gold, given the trillion dollar numbers of debt instruments out there?


The Prof can be contacted by email at profvonb2@aol.com

Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.

Return to the The Gilded Opinion Index Page

The Rocket School of Economics -- The Lecture Series Index

  • 22 May 2009 -- An Often Overlooked Issue!
  • 28 Mar 2009 -- Problematic Banking Systems!
  • 14 Nov 2008 -- What Exactly is an Asset?
  • 23 Aug 2008 -- Through the Looking Glass?
  • 02 Aug 2008 -- Compounding to the Downside!
  • 26 May 2008 -- Back to Basics Again!
  • 31 Mar 2008 -- The Broken Watch -- Part 2.
  • 27 Mar 2008 -- The Broken Watch -- Part 1.
  • 06 Feb 2008 -- The Financial Equivalent of Faulty Towers.
  • 10 Dec 2007 -- Monetary Systems & Productive Assets.
  • 14 Feb 2007 -- Divorced from Reality
  • 06 Sep 2006 -- Gold, Bankers, the Trade Deficit and Unsettled Transactions
  • 19 Jun 2006 -- When is a Reserve Not a Reserve?
  • 31 May 2006 -- The significance of August 15, 1971.
  • 08 Apr 2006 -- Keep Your Eye on the Ball!
  • 30 Mar 2006 -- What came first?
  • 11 Mar 2006 -- An Unanswered Question.
  • 08 Jan 2006 -- Where have all the projects gone!
  • 11 Dec 2005 -- Gorillas, Rising Gold Prices and Depreciating Paper Currencies!
  • 23 Oct 2005 -- Custodial Risk.
  • 16 Sep 2005 -- An Inherent Flaw.
  • 08 Aug 2005 -- Central Banks and 'Reserves'.
  • 31 Jul 2005 -- Central Bankers, Actors and 'We'.
  • 17 Jul 2005 -- Unintended Consequences! -- Part 3.
  • 07 Jul 2005 -- Unintended Consequences! -- Part 2.
  • 25 Jun 2005 -- Unintended Consequences! -- Part 1.
  • 14 Jun 2005 -- The Two Greater Fools Theory.
  • 03 Jun 2005 -- Real Money, Funny Money and YOU -- Part 4.
  • 30 May 2005 -- Real Money, Funny Money and YOU -- Part 3.
  • 26 May 2005 -- Real Money, Funny Money and YOU -- Part 2.
  • 21 May 2005 -- Real Money, Funny Money and YOU -- Part 1.
  • 09 Nov 2002 -- Carrying a Big Stick.
  • 17 Sep 2002 -- Wishful Thinking!
  • 27 Jul 2002 -- Gold Bugs Beware -- part 2.
  • 10 Jun 2002 -- Gold Bugs Beware!
  • 06 Apr 2002 -- Currencies versus Gold.
  • 26 Jan 2002 -- Bear Market Strategies.
  • 01 Jan 2002 -- 2002 -- A Perspective.
  • 20 Oct 2001 -- The Storm Clouds are Gathering.
  • 30 Sep 2001 -- What to Say?
  • 01 Jul 2001 -- ...Said the Fly to the Spider.
  • 14 Jun 2001 -- Upward and Downward!
  • 28 May 2001 -- Volatility Time, Again!
  • 14 May 2001 -- The Coming Bull Market in Gold Stocks?
  • 24 Feb 2001 -- High Hopes, Wishful Thinking & The Absurd
  • 20 Feb 2001 -- Who Put the Holes in the Swiss Cheese?
  • 22 Jan 2001 -- US Dollar Admits Identity Crisis!
  • 16 Jan 2001 -- Dear George W.
  • 24 Nov 2000 -- The Bubble Has Burst
  • 11 Nov 2000 -- The Media, Bull Markets & the Gold Price
  • 02 Nov 2000 -- Gold Stocks
  • 29 Oct 2000 -- Oh The Tangled Web We Weave ...When We Set Out to Deceive
  • 24 Oct 2000 -- A Mystery!
  • 16 Oct 2000 -- A Peso Here ...and a Few Thousand Pesos There
  • 10 Oct 2000 -- The Unfolding
  • 30 Sep 2000 -- What's Wrong with THIS Picture?
  • 25 Sep 2000 -- Buy Gold Now!!
  • 23 Sep 2000 -- The Times, They Are a' Changing
  • 15 Sep 2000 -- Time WILL Tell!
  • 27 Aug 2000 -- SS "Paper Assets" Begins to Take on Water
  • 06 Aug 2000 -- The Indian Summer
  • 26 Jun 2000 -- A Yellow Brick Wall
  • 22 May 2000 -- The King IS Naked
  • 30 Apr 2000 -- Goodbye Yellow Brick Road
  • 18 Apr 2000 -- Beware the Ides of March, April and May
  • 08 Apr 2000 -- Really, Sir Aldot!
  • 25 Mar 2000 -- Where To From Here?
  • 18 Mar 2000 -- The Gnomes of Zurich
  • 12 Mar 2000 -- The "New" Economy??
  • 06 Mar 2000 -- Two Questions
  • 04 Mar 2000 -- Iceberg Dead Ahead!
  • 28 Feb 2000 -- The Wizard of Oz
  • 06 Feb 2000 -- Here We Go Again!!
  • 15 Jan 2000 -- Comments on the Gold Market
  • 29 Dec 1999 -- No Raw Ingredients Required
  • 28 Dec 1999 -- No Way Out
  • 14 Dec 1999 -- Ho, Ho, Ho!
  • 07 Dec 1999 -- Greenspan's Bubble
  • 03 Dec 1999 -- Early Warning Signs


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