Former congressman Ron Paul recently posted an interesting article on GoldSilverWords entitled, “Watch Out When People Start to Distrust our Money”. Paul offered several important insights, but, his central argument was that because the fiat dollar has no intrinsic value, whatever value it appears to have is based entirely on the people’s trust. So long as people continue to trust in the dollar, it will have value. If people lose that trust, the dollar’s value will diminish or even disappear.
According to Mr. Paul:
“Now we have that strange phenomenon of this unbelievable trust in the US Dollar. This could only happen because our country is (still) wealthy, but a lot of the wealth is superficial because it’s based on debt. So, the people are going to be really shocked when the hit finally comes because this system has existed for so long and longer than any paper currency before it.”
Mr. Paul’s reference to “unbelievable trust” in the US dollar implies that the world’s trust—though strong—is irrational.
Yes, the US appears to be wealthy—but that can’t be true since we’re the biggest debtor nation in the world.
More, how can an economy that treats debt (promises to pay) as a fundamental asset be regarded as anything other than irrational?
Yes, the current system of US fiat dollars has lasted longer than virtually any other previous fiat currency system. Some view that longevity as evidence that the fiat dollar is invincible. Other see it as evidence that the dollar’s end must be near.
“Right now there’s a lot of trust by foreign takers of our dollars, they keep taking them. And as long as they do that, we’re going to limp along and the bubble keeps getting bigger and bigger. . . . and the inevitable bust gets worse.
“Right now, they have no other place to go. They could go and beg Europe to print Euros, but they trust the dollar more. As long as they keep doing that, these insane policies will continue.”
Paul is right. No matter how irrational and groundless the world’s trust in the current fiat dollar may be, the fact remains that the world does trust the fiat dollar more than any other currency. Therefore, the intrinsically-worthless, fiat dollar not only has value but remains politically powerful—and the price of intrinsically-valuable gold remains vulnerable.
How much longer will the world continue to trust the dollar?
• Mr. Paul’s observations about the central relationship between trust and fiat currencies raise interesting implications.
For example, only a nation with a very strong economy, a very cohesive people, and a demonstrated capacity to be productive is likely to be trusted enough by both foreign countries and domestic citizens to have a fiat currency.
In the aftermath of WWII (when all other western nations were damaged or destroyed) what currency could the world trust other than the gold-backed dollar? Later, when the dollar became pure fiat, the reality remained that no other currency was as trusted as the fiat dollar.
But if a nation’s government is corrupt, economy falters and people are divided by unenforced immigration laws, people will increasingly distrust that nation’s ability to repay its debts with goods and services it may one day produce. Therefore, people will tend to demand real payments in gold and silver coin rather than fiat currency (IOUs).
Only a truly strong nation is likely to be able to create, impose and maintain a fiat currency. Weak nations can’t.
Insofar as this argument is valid, we could look back on American history and argue that our various attempts to impose a fiat currency reflected our growing national strength. Our fiat currency failures reflected our national weakness.
America’s one great success at issuing fiat currency (since A.D. 1971) has been based not only on American economic and military power, but also on the relative weakness and chaos seen in the rest of the world. So long as the world was relatively weak and we were relatively strong, our fiat dollars were trusted and relied on around the globe.
However, the great advantages to successfully issuing a fiat currency also require great obligations to respect and maintain that fiat currency. Inevitably, the hustlers, con-artists and self-promoters gain control of the fiat currency production system and start to cut deals and impose laws that are self-serving and irrational. These abuses tend to strengthen the government and/or special interests and thereby weaken the nation. The middle class starts to disappear. As the nation is increasingly weakened by too much debt and too few jobs, trust in the nation’s fiat currency begins to wane. When that trust is finally (or primarily) exhausted, the fiat currency fails.
• Given that the fiat dollar’s purchasing power has fallen about 97% in the just the past forty years, it’s obvious that trust in the dollar has also fallen—but not proportionally. In fact, as Mr. Paul indicated in his reference to people’s continuing “unbelievable trust” in the fiat dollar, once trust in a fiat currency is established, it’s difficult to dislodge.
For example, we’ve all seen images of people in A.D. 1921 Weimar Germany pushing wheelbarrows full of fiat currency to the grocery store to purchase a loaf of bread.
Q: Why didn’t the German people simply say “this is stupid” and stop taking or spending fiat currency?
A: Because they’d been conditioned to trust that currency and believe in that currency as if it were a religious faith. They were no more willing to give up their trust in fiat currency than Catholics are willing to give up their faith to become Protestants.
Look at Zimbabwe. Between A.D. 2008-2009, that country suffered an almost comical hyperinflation. Hyperinflation peaked at nearly 80 billion percent in November A.D. 2008. If you accepted a Zimbabwean fiat dollar at 12:00 noon, it was probably worth no more than a dime by 12:01. And yet, the Zimbabwean people continued to trade in their hyper-inflated currency for most of another year.
Why? Because: 1) they’d come to trust that fiat currency; and 2) they had no other domestic currency to trust.
Zimbabwe has failed to create another domestic fiat currency. The Zimbabwean people no longer trust their government to produce another Zimbabwean fiat currency.
Solution? They use fiat US dollars—which are every bit as intrinsically-worthless as Zimbabwean fiat dollars. But, unlike the Zimbabwean fiat dollars, the US fiat dollar is still “unbelievably trusted”.
No matter how irrational that trust may be, so long as that trust remains, the fiat dollar will be a viable currency—in Zimbabwe and even in the US.
But, who long will that trust to remain?
The Love of Money
I’d bet that our trust in any fiat currency can continue almost indefinitely—unless there’s a default by the government or central bank that issues that fiat currency.
So long as the gov-co can continue to “spin” fiat currency “out of thin air” (or even out of a vacuum), and people maintain the illusion that they’re being paid when they receive fiat currency, they’ll merrily pay and receive the fiat currency. They might grumble that the wheelbarrows they need to haul their hyper-inflated currency to market are too small, but they’ll still trust their fiat currency.
Look at the United States. Our government has been technically bankrupt since at least A.D. 1971 when we stopped redeeming fiat dollars held by foreigners with gold. We haven’t actually “paid” any of our bills with gold or silver for over forty years. Instead, we’ve merely “discharged” our debts with worthless pieces of fiat currency.
Does anyone much care?
Does anyone even understand?
So long as the Federal Reserve can still spin trillions of fiat dollars into existence and the federal government can discharge its debts with intrinsically-worthless fiat dollars, the game goes on. Why? Because the people of the US and of the world continue to trust in fiat dollars more than they do in other currencies.
This “unbelievable trust” may be evidence of a Biblical warning: the love of money is the root of all evil. I.e., it’s not the money that causes evil. It’s the love of money that’s the “root” (or cause) of all evil.
When people cling to an intrinsically-worthless, fiat currency, is that devotion evidence of an “unbelievable trust”? Or an “unbelievable love”?
Even if our “affair” with fiat currency isn’t motivated by love and is only motivated by trust, we’re still caught in a relationship with a paper whore who’ll always deceive us, rob us, and lead us to personal, national or even global ruin.
And yet, we have “unbelievable trust” in that paper whore.
If you want to know when the dollar is going to die, figure out when the government will finally be forced to admit that it can’t repay much or even all of its debts. At the moment the government openly and expressly defaults . . . at the moment the President is forced to finally say “Th-th-that’s all, folks!,” the public will lose its last vestige of trust in the fiat dollar and the fiat dollar will die or at least suffer a massive devaluation.
Where might we expect a default?
• Under the Bretton Wood’s Agreement of A.D. 1944, the US gov-co promised to redeem all foreign-held paper dollars with gold. The nations of the world, bound up in WWII, trusted the US promise to redeem paper dollars with gold.
However, in A.D. 1971, President Nixon broke that promise when he closed the “gold window” and stopped redeeming foreign-held, paper dollars with gold (and thereby reduced the dollar to a pure fiat currency).
That was a default.
The dollar suffered a severe devaluation, but the people of the US and world continued to trust in the (now fiat) dollar and the US and world economies continued to function.
• In the 1950s and 1960s, Germany (fearful of being invaded by the Soviet Union) deposited about 600 hundred tons of gold with the US gov-co. The gov-co promised to return Germany’s gold on demand. Germany trusted the US gov-co’s promises to safely store its gold and return that gold when asked.
In A.D. 2012, Germany demanded 300 tons of its gold be returned by the US gov-co. The US (which claims to hold nearly 8,200 tons of its own gold) refused to honor its promise to return the 300 tons of gold when Germany asked for them.
That’s a default.
But, again, the people of the US and world didn’t notice and therefore maintained their trust in the fiat dollar. Based on that trust, the fiat dollar lives and US and world economies continued to function.
My point is that it the public will not lose trust in the fiat dollar until there is a general default that is of sufficient magnitude to affect almost everyone. Serious, governmental defaults whose impacts are confined to one or more foreign countries or only limited segments of the US population may be troubling, but they will probably not be sufficient to individually cause a sudden and nearly complete loss of trust in fiat dollars.
This implies that the dollar will not die without a “general default” that affects virtually all Americans.
Inflation is a default. Inflation allows borrowers to “pay off” their debts with “cheaper” dollars. When borrowers can pay off their debts with “cheaper” dollars, they aren’t actually “paying” their debts in full. Thus, inflation is a kind of slow, moderate default.
Since the dollar became a pure fiat currency in A.D. 1971, the dollar has lost about 97% of its purchasing power. Because the dollar slowly lost only about 2% of its purchasing power per year, the people didn’t notice or mind this default. Instead, they continued to trust in fiat dollars and the US and global economies continued to function.
The point to these examples of previous and ongoing US fiat-currency defaults is that a mere technical default is not enough to collapse a currency so long as the people of the world, and especially those of the nation, continue to trust that currency.
We don’t care in the least if our government robs foreigners who hold fiat dollars. We don’t care if our government robs Germany of several hundred tons of gold. We don’t even mind if our government robs us by means of inflation, so long as the rate of inflation is fairly modest (say, 20% or less per year). Even when faced with general default by inflation, our trust in fiat dollars remains fairly solid.
But Americans, presumably, would care if government robbed us of a lot of our wealth in a very short period of time.
For example, if the US and/or state governments refused, or were unable, to pay most or all of the ten million government pensions due to former or current government employees, that default might be sufficient to diminish our trust in fiat dollars—but the dollar would still function.
If the gov-co defaulted on most or all of the So-So Security funds currently due to the 58 million So-So Security retirees, dependents and survivors, that default might diminish our trust in fiat dollars—but enough trust would probably remain for the dollar and our economy to continue to function.
If the US gov-co refused, or was unable, to pay most or all of the funds currently received by 65 million welfare recipients, that default would diminish our trust in fiat dollars—but the dollar and our economy would continue to function.
And then there are millions of government subsidies for corporations and salaries to be paid to government employees. So long as government defaults on just one “class” of its debts at a time, we shall probably maintain sufficient trust in the fiat dollar for it and our economy to survive. Yes, we might be limping along in a recession or depression, but the dollar and the economy would continue to survive—unless, there was a general default of sufficient magnitude that impacted virtually everyone, that our trust in fiat dollars virtually collapsed.
In the end, there are two kinds of general default: 1) “hyperinflation”; and 2) express, overt refusal to pay debts.
“Inflation” describes an economic state wherein the currency is moderately devalued but trust in the currency generally remains. For example if all of America was experiencing an inflation rate of, say, 20%, we’d be bewildered and angry, but we’d still maintain our trust in the fiat dollar. That trust might be diminished, but it would still be sufficient for the dollar and the economy to survive.
The fiat dollar can survive inflation for a long time. It can’t survive hyperinflation for long.
“Hyperinflation” doesn’t simply signify a higher rate (say, 50%) of inflation. “Hyperinflation” describes an economic state wherein: 1) a fiat currency is significantly devalued; 2) that devaluation seems certain to continue or even accelerate; and 3) the people therefore lose trust in that currency.
“Hyperinflation” is primarily about a loss of trust in a fiat currency.
For example, during a period of inflation, you might know that your $1,000 paycheck will only worth $900 a year later—but that’s not much cause for concern. If you’re living hand-to-mouth like most Americans, you’ll spend your $1,000 within a week or two and the loss of purchasing power caused by 10% annual inflation will be trivial.
However, if you receive your paycheck for $1,000 on Friday, and you know that its purchasing power will be reduced to $500 within a month (loss of $15 to $20/day), you’ll spend that $1,000 almost as fast as you can cash your check. Why? Because you no longer trust the currency to retain its purchasing power.
If the rate of hyperinflation is even faster, the people’s loss of trust in the fiat dollar will also accelerate. That trust won’t be completely lost overnight. It’ll probably take a year or more of hyperinflation to destroy virtually all trust in a fiat currency.
But any hyperinflation will cause not only a default (paying debts with “cheaper” dollars), it will kill trust in the currency.
• The second form of default is an express admission by a national government that its debts can’t be paid. The effects of that admission might be minimized with claims that the debt will be paid later, or the issuance of “vouchers” or some such. But as it becomes apparent that the debt will never be paid in full, trust in the national currency will wane, that currency will quickly become less and less valuable, until it ceases to function.
The official US national debt is nearly $18 trillion. John Williams (shadowstats.com) believes it’s closer to $90 trillion. The Congressional Budget Office has calculated that, including unfunded liabilities, the national debt is over $200 trillion.
We might be able to repay $18 trillion (about $55,000 for every man, woman and child).
We won’t be able to repay $90 trillion ($280,000 per capita).
We will surely never be able to repay over $200 trillion ($630,000 per capita).
That means there’s going to be a general default on the national debt. When that happens, trust in the fiat dollar will evaporate, the fiat dollar will die and we will be left to look for a new-and-improved currency that everyone will trust.
In the midst of a loss off trust in the fiat dollar, what might the people trust? A new fiat dollar colored pink rather than green? A new digital currency on a universal debit card?
I don’t think so.
Once the fiat dollar dies, the only alternative “currency” that people are likely to trust will be gold and silver. The demand for gold and silver should rise dramatically, and so should the price.
We might stumble into an era of hyperinflation. If we do, that’ll kill the fiat dollar.
If we don’t see hyperinflation, the national debt is too big to ever be repaid. Sooner or later, there must be a default on the national debt. When that inevitable default takes place, trust in the dollar will wither, the dollar will die, and the demand for gold will be huge.
The ultimate reason for owning gold is to insure your wealth against an inevitable loss of trust in the fiat dollar.