PrintJune 14, 2010
The World's Money Problem
The euro is in big trouble because there is too much debt behind it -- so much that there is talk that it may fall apart. Jim Rogers, the legendary investor, thinks the euro may not be around in fifteen years. Others think it will not be around in fifteen months.
The fears are fully justified. It is hard to see how Germany and Greece can coexist within one monetary framework. Germans work and save, Greeks party and spend. Such a marriage cannot last very long. Neither can one in which Germans are married to the French. The French have the 35-hour working week and take long lunch breaks. The German people will not subsidize that forever.
During their argument over the euro bailout, Sarkozy threatened to leave the common currency if Germany did not pay up. He shouted and got red in the face. Angela Merkel became alarmed and agreed to cough up billions. That was a mistake. She should have said "good riddance" instead.
Investors are now spooked and are dumping their euros as a result. Many are buying dollars instead. This is a case of desperation, since the dollar is in worse shape than the euro. The sovereign debt across the eurozone is about 80 percent. America's is 10 percentage points higher. According to the Obama administration, America's public debt will soon exceed 100 percent of GDP. Add to that more than $100 trillion in unfunded liabilities. There is no way this can ever be paid; in the long run, the dollar is a dud.
So why are central banks and investors buying dollars now? The answer is simple: Doomed though it may be long-term, the dollar seems the best alternative at the moment.
It all boils down to this: Where do you store your excess wealth? Or to put it differently, what do you use as your store of value? In the past, the answer was simple. Kings and wealthy people had their liquid wealth primarily in gold. If you were rich, you got yourself a pile of gold, and that was that. Gold was where you kept your money, because gold was money.
After World War II, governments ceased to use gold as money. Instead, they agreed to use the U.S. dollar as the anchor for their currencies. The value of national currency units was no longer set by the amount of gold for which it could be exchanged, but by their exchange rate against the dollar. The dollar itself could be redeemed for gold. This how the dollar became the world's reserve currency.
Then, in 1971, Richard Nixon took the dollar off the the last vestiges of the gold standard. The rest of the world grumbled, but they still retained the dollar as the reserve currency. The dollar in effect became the new gold standard.
But there was a problem. When Nixon did away with the gold standard, the dollar became a pure fiat currency. Unfortunately, fiat currencies never survive for very long. Politicians always make sure of that. Freed of the golden handcuffs, they invariably start spending more than they they can afford. To cover the gap, they borrow. Eventually they cannot raise enough money to pay for the debts, so they simply print more money. This inflates the supply, which causes the value of money to drop while prices rise. This is how fiat currencies are debased.
The dollar is being debased by the immense debts and liabilities of the U.S. government. Central bankers and investors know it. But what are their options? Where are they going to store their wealth? Everything considered, there is no other currency that is better. Most major western currencies are debt-ridden. Those that are not are not big enough to serve as a global investment vehicle. The Chinese yuan is off the table because is not easily convertible -- plus you would not trust the communists anyway. Even though the dollar will eventually fold, it is still the best among the bad choices.
Those with cash are trying hard to find alternatives. The Chinese are increasingly investing a portion of their surpluses into tangible assets across the globe. They are doing it quietly, of course. They do not want the world to think they are dumping the dollar, because it would bring down its value. Having nearly one trillion invested in treasuries, they would lose big time.
Then there is gold, which has been climbing steadily. This is because gold is a hedge against currency weakness. Given how weak currencies are, gold's bull run is no surprise. But gold is also more than just a hedge. It has never quite ceased to be money. Even though the political elites have been trying to discredit it, gold has never completely lost its store of value function.
Gold has always been the hard money under the surface of legislatively imposed fiat currencies. This is no accident, since gold has a set of qualities that make it uniquely and naturally suited to function as money. Of particular advantage is the fact that unlike paper currencies, it cannot be manufactured at will. For this reason, gold tends to be stable in relation to tangible things. A barrel of oil today, for example, is worth roughly the same in terms of gold as it was thirty years ago.
When the hour of reckoning arrives and the weight of debt finally breaks the back of fiat currencies, gold may well emerge as prime money once again. That would be a great thing, indeed. It would, for one, make it much harder for politicians to ruin us with debt. Honest money would surely do us good.
