Column #299 May 28, 2021
In today’s Wonderland world, people may be more disconnected from reality than ever before. One of the major disconnects is in the understanding of money. Ask 100 people to explain the classical attributes of money and I’d be surprised if even one person knew more than two or three. Simply saying money is gold, or silver, or greenbacks, or franks, or crypto does not explain even one attribute of money. And, how many people understand that money must fulfill every attribute, not just some of them?
What’s tricky about money is that unless you know what it is, what it isn’t, and what’s going on in the marketplace, you’re living in a Wonderland where you can be left up a creek without a paddle. The reason it’s so important to understand our Wonderland is that most people live in cites and do not have sustainable lifestyles. By that I mean they don’t even raise their own food or keep reserves of any kind on hand for emergencies. They are totally dependent on being able to purchase 100% of their day-to-day needs with cash flow or savings in order to survive. That’s why, as a business that relies on its customers, we want everyone to be sustainable which is why we’re addressing this topic.
Before I explain the definition of money, stop and think for a moment and jot down the attributes you believe best defines real money.
Physical: Money must be a physical thing. Otherwise, it can’t fulfill its many important functions.
Divisible: Money must be able to be divided and combined without altering its value per unit of measure. This is why pigs can’t be money.
Homogeneous: No matter the quantity or quality, value is the same per unit of measure. This is why diamonds can’t be money.
Acceptable: Money must be universally (known all over the world) recognizable and accepted as money.
Clear as to Value: The value, which is based on a unit of measure, must be universally recognized and easy to quantify.
Standard of Value: Money must be a recognized standard by which the relative values of other goods and services can be determined.
Durable: Money must stand the rigors of time and retain value. For instance, gold coins and bars, recovered from the sunken Spanish treasure fleets of 300 years ago, are still being found in pristine condition. Gold coins that melt down into blobs in a fire retain their intrinsic value.
Portable: Money needs to be portable on a person and transferable to others. Therefore, small quantities must have high value.
Limited in Supply: The supply of money has to be limited. It can’t be easily counterfeited nor created.
Store of Value: This is extremely important. Money must retain its value relative to goods and services over thousands of years. That way, money set aside as savings for a hundred years will still buy about the same quantity and quality of goods and services as when it was set aside.
This is where it gets tricky and Wonderland begins. People today have been conditioned to believe that dollars, yen, franks, pounds, crypto, etc. are money. They also recognize that gold is valuable and has been money for thousands of years. But the old saying that “bad money drives out good” is still true. Consequently, in our current Wonderland existence, citizens of each country use their currencies for trade. Therefore, they measure everything’s value in terms of their currency. In America, Americans value everything in terms of dollars—not gold, or silver, or yen, or rubles. Just dollars.
But dollars can’t be money because they are IOUs. A dollar is a piece of paper that is a call on an institution (bank or government) to deliver something on demand. Our country’s paper notes evolved over time. Originally they were defined by a Spanish silver coin. Then they were redeemable in both silver and gold. The silver and gold option was unworkable because their relative values fluctuated which resulted in arbitrage by foreign nations. To stop the chaos, the dollar was redefined to just a gold certificate. From 1834 to 1934 the United States Congress defined the dollar as 23.2 grains of pure gold which was the only period during which the dollar was mostly stable in value in terms of purchasing power. In 1934 President Roosevelt made gold illegal for American citizens to have and devalued it from 23.2 grains to 13.71 grains of pure gold—raising the official price of gold to $35 per troy ounce.1
In 1971 President Nixon ordered the U.S. Treasury to no longer give up gold in exchange for international dollar claims. From that moment on only Federal Reserve Notes (FRNs) have been printed. They do not have an obligation or promise to pay anything even though the term “note” implies a promise to pay something. Today’s dollar is strictly fiat money, which is “money” by government decree. The collateral behind FRNs is chiefly held in the form of U.S. Treasury, federal agency, and government-sponsored enterprise securities. In other words, the FRN is a note payable in a debt instrument that’s payable in a FRN.2
Without a domestic tie to gold, our politicians had their way with spending. That resulted in 87 years of dollar debasement and, during that time, our government and academia convinced everyone to believe the FRN is money. Yet the dollar is the exact opposite. To create a FRN, debt is created at the same time. Therefore, the creation of more FRNs not only creates more liquidity, but also more debt. So, when people say the money supply is increasing, what’s also increasing is dollar-denominated, interest-bearing debt!
Following the American example, all of the world’s currencies have been losing their purchasing power. People saw it in rising prices for everything including their investments such as real estate, stocks, bonds, commodities, and collectibles. They also saw their currency-denominated debts appear to shrink relative to the value of their holdings and rising cash flows. But there’s a catch in this good news.
Debt increases the amplitude of business cycles by acting as an accelerant for both boom and bust times. It’s real exhilarating on the upside. Unfortunately, more debt is not stronger debt. More debt is weaker debt. So, even when the debts to equity ratios seem to stay balanced on the upside, debt-based consumption cannot be sustained in a straight line for extended periods of time. So, it’s when consumption slows that debts, all of a sudden, can cause economic activity to go in reverse.
This is when, for economic survival, everyone has to understand the difference between money and credit. Recessions cause assets to drop in value relative to the dollar. It happens when debts that are collateralized by assets come under pressure and are called in by the lenders. Also, if business and personal cash flows shrink even a little, the ability of businesses and citizens to service their debts is compromised. When debts are being called, the pressure to pay off dollar-denominated debts can force the sale of everything to get dollars. That means everything priced in dollars can drop like a stone—including gold. On the inside of the debt bubble the dollar will be gaining in value!
What I’ve just described would be a deflationary implosion which is just the opposite of what everyone is expecting today. How the current government and the Federal Reserve will react is the next big unknown. My guess is that our government will dictate a typical bureaucratic response that jerks the nation in the wrong direction. If so, at some point dollar holders will need to convert their dollars to gold.
Here’s how I figure when it’s time to switch from gold to the dollar and then back to gold. It’s based on the cost of gold production. Currently, many major gold mining companies have 50% profit margins. In other words the cost to mine an ounce of gold is around $900 an ounce and the market price is $1,900 an ounce. That’s boom times for gold mining companies.
When gold is trading close to the average cost of production, which means many mines will be losing money, that’s a floor for the gold price. Here’s what we saw happen in previous times when it paid to swap dollars for gold. In 1970, when gold was $35, it cost Homestake $42 an ounce to recover one ounce. In 1999-2001, when gold was trading as low as $250 an ounce, it cost Agnico Eagle about $200 to mine an ounce of gold.
If there is a deflationary period ahead, I think the scramble for dollars could cause the dollar-to-gold ratio to drop to less than $1,000. The stock market would drop even more percentagewise. Instead of people paying more than the asking prices for homes, homes could sell below appraised values. Naturally, as the debt liquidation runs its course, at some point a bottom is reached and there will be opportunities galore.
No one can say exactly how events will turn out months and years from now. This scenario I’ve presented is just one possibility. But it’s similar to the money and credit cycles of the past. Right now, we’re seeing too many tulip-bulb-mania signs and they are not sustainable. So I keep thinking we should be on guard. This may sound crazy the way everyone is thinking these days, but hoarding dollars at home may be a good strategy for the next year or so.3
If we do get a credit contraction, how the younger generations handle it will be most interesting. The elders have lived through these cycles before and we know they aren’t fun. But we lived through them and learned that each one is unique.
To your health.
Ted Slanker has been reporting on the fundamentals of nutritional research in publications, television and radio appearances, and at conferences since 1999. He condenses complex studies into the basics required for health and well-being. His eBook, The Real Diet of Man, is available online.
Don't miss these links for additional reading:
1. History of the Dollar from BeBusinessed
2. What Is a Dollar? by Edwin Viera from Foundation for Economic Education
3. Tulip Mania from Wikipedia