Since President Nixon severed the last links to the Bretton Woods agreement in 1971, the world has been living in a new era. A new era of global fiat currency.
The previous Gold Standards had provided inherent checks and balances on national monetary policy, preventing unfettered monetary inflation (the creation of new money). In principle, under a gold standard the value of currency issued has to be backed by a certain amount of gold. Since 1971, the controller of the world reserve currency has been in the enviable situation of being able to create whatever money it needs to be able to pay its way. The last 40 years have been four decades of inflation of the money supply.
Inflation let loose
The mini recession of 2001, following the bursting of the Internet bubble, should have seen a restorative reallocation of capital and a contraction in the amount of credit. The political masters at the time, however, were uncomfortable with the idea of economic pain and so embarked down the road of loose monetary policy with historically low inflation rates.
At a time when the excesses of the late nineties should have been curtailed, and capital reallocated from unproductive schemes into productive ones, the credit bubble was re-inflated. The massive misallocation of capital that resulted was eventually halted by the meltdown of 2007.
As we all now know, the huge financial fallout in 2007 and the Keynesian dogma of our politicians meant that most Western governments have taken on huge amounts of debt in order to bail out financial institutions. The total amount of these debts is pretty staggering – even the official numbers! The United States Government officially recognises something like $40 trillion of debt. That is a huge number in relation to the $14 trillion or so annual GDP. However, a number of independent analysts have put the “real” debt figure at over $100 trillion.
This “real” figure includes unfunded liabilities such as social security, health and retirement benefits. The bottom line is that the debts are so huge that it does not seem likely that they could ever be paid back, under normal circumstances.
There are only two ways the debt problem could be eliminated. The first is for the US to default. This would be extremely embarrassing if not shameful, would push up the US cost of borrowing and have untold negative consequences on the world economy. Of the two options, this is the least likely.
The second solution is to further inflate the money supply and thereby pay the debt with newly created money. This solution is very easy for the US government – they would not default on payment, it would just be that the dollars paid to creditors would have less value than before.
The reason to hold hard assets
This isn’t just a problem for the United States. Although the dollar is the currency of the US, it is also the world reserve currency and most commodities (which we all rely upon) are priced in dollars. Therefore, if the US is intent upon destroying the value of the dollar in order to pay its debts then the price of everything valued in dollars is going to rise. If you agree that dollar destruction is indeed upon us then owning hard assets (especially gold) should be seen as essential in order to avoid destruction of your wealth.