What is the Question Then
The fiat money of the day has a price, but it is only redeemable for other fiat money at the going rate. It has no anchor and its only value lies in its currently accepted role as a medium of exchange and in its "ability" to measure value (note that I've excluded "a store of value"). It is not fixed in supply, and political necessity has often created a volatile "price," which is why its ability to reliably measure value is in question. For the purpose of this essay, I will refer to the exchange rate as a price, in order to make a point. Anything that is infinite in quantity has no material price and no value, except in its use. Water is necessary for our survival so it has a value, yet where it is abundant, it is generally free to consume as one pleases. Where its marginal utility1 can decline to a theoretical zero, it has no price. In the case of money, it is useful, and maintains a constant marginal utility. I have yet to meet anyone who didn't need more of it. Therefore, it is always tempting to increase its quantity. The paper, which is used for the "legal tender," on the other hand, is useful as a medium of exchange, but it is not reliable to us beyond that. It is not valuable to us if it cannot preserve its price. It loses its value as a standard, and as a stable measure of value, it loses its value as a store of wealth, and it loses its value as a medium of exchange if it becomes less widely accepted because of its uncertain price. To be sure, these effects usually occur slowly over long periods of time, which is why we probably never seem to notice them. However, they may be rapidly approaching their climax.
Money has always been backed by gold to avoid just this. Today there is only an implicit, but not real, commitment by the Government to preserve the value of your savings. What this means is that when it becomes politically expedient to devalue your savings, the Government will not hesitate, the same way that every Government has chosen to debase the coin of the realm in favor of more prosperity. We don't clearly see this because the relative price of our money (the US dollar) has so far been rising, and we have been reaping and enjoying the benefits of a false perception of rising value. However, this has resulted in a number of global economic imbalances, which can only correct themselves if the price of the dollar properly reflects its relative abundance, or the FED corrects its relative abundance by raising interest rates to stabilize its price, and therefore value.
Raising interest rates, as I believe we are about to see, however, can induce a severe credit contraction that will affect the wealth and currencies of foreign economies, if that isn't underway already. Initially, it has favored the price of the dollar, but at the expense of foreign liquidity. Furthermore, a recession in the United States would drag down foreigner's US dependent prospects for growth. The price of their dollar denominated assets would contract, which will likely drag down with it, their perceptions of the value of the dollar more rapidly than its price at first. This unsustainable divergence should create a global incentive to quickly repatriate overpriced dollars. If the incentive becomes reality, and Friday's action is perhaps an indication, the dollar price of gold should rise, initially revealing the divergence, and ultimately forcing it to rise towards its true value. If such an event accelerates, and inhibits a general confidence in the dollar's ability to function as a medium of exchange, the actual value of gold may start to rise as well, initiating a reinforcing loop between price and value, which would likely escalate. Once this process is set into motion, there is not a damn thing the Government can do about it.
"There is no institutional mechanism by which we could ever duplicate the kind of financial system we have, under a system that relied almost entirely upon gold. Of course, you could always have a system that used a lot of paper that was in some sense convertible into gold. You could always find a price of gold that you could convert that paper theoretically into gold. But I don't think anyone has thought in terms of the enormous price of gold that would be required in order to achieve that." -- Robert Mundell, 1999 Nobel Laureate in economics (sponsored by the Swedish Central Bank)
I have thought about it, though I'm sure in reality I would be very wrong. Well, at least some people had better hope so. Remember the Dow 36,000 prophecies? Coincidentally that was close to the number that showed up on the back of a napkin as I tried to estimate the value of the global money supply today, and divide it by 120,000 tons, etc.
By Edmond Bukos
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