Gold vs. Inflation

IN THE NAME OF ALLAH – THE SOURCE OF MERCY – THE MOST MERCIFUL

Those who work the hardest and are paid the least, suffer the most from the constant erosion of money's value. Since money has an ever declining value, a financially wise person must constantly seek ways to create and produce more and more value.

Under a Gold standard, the amount of credit that an economy can be support is determined by the economies tangible assets. Since every credit instrument is ultimately on some claim on some tangible asset but government bonds are not backed by tangible wealth only by the governments promise by payout by future tax revenues and cannot be easily absolved by the financial markets. A large volume of new government bonds can be sold to the public only progressively higher interest rates, thus governments deficit spending under a gold standard is severely limited. The abandonment of Gold standard made it possible for the welfare states to use the banking system as a means to unlimited credit. They are created papers in the form of government bonds which threw a complex series of steps the bank accept in place of tangible assets and treat as if they were actual deposits. This is just on a ledger in the federal reserve as the equivalent as formerly Gold. The holder of a government bond or a bank deposit created by paper believes he has a valid claim on a real asset. The Law of supply and demand says as the supply of money of claims increases relative to the supply of tangible assets in the economy the prices must eventually rise. Thus earning saved by the productive members of the society lose value in terms of goods, so if you are saving money you are losing money in the system. 

The example of monetary inflation (creating new money out of nothing). Monetary inflation is institutionalised counterfeiting, which means it is a form of theft. Although it is (or at least should be) intuitively obvious that the economy could never, under any circumstances whatsoever, benefit from an increase in the amount of theft, it is unlikely that someone without a grounding in Austrian economics would be capable of understanding or explaining, in practical terms, exactly why this is so. After all, during a financial crisis it can seem as if a shortage of money is a large part of the problem and that 'greasing the wheels' with more money is just what's needed to get us through the rough patch.

To fully appreciate why monetary inflation is always a practical problem rather than just an ethical problem, you have to understand the relationship between money-supply changes and the boom-bust cycle ("Austrian Business Cycle Theory"). More specifically, you have to understand that the most important adverse effect of monetary inflation is not the reduction in the purchasing power of money that it eventually leads to, but the distortion it causes in relative prices. These relative price distortions lead to widespread mal-investment and the large-scale destruction of wealth. Think of how much wealth was ultimately destroyed by the monetary-inflation-fuelled boom in US residential real estate. The reduction in the dollar's purchasing power is trivial in comparison.

There will eventually be a complete collapse of the global monetary system, but I don't have a strong opinion as to how we will get from here to there (other than generally via the rapid creation of money out of nothing) or when we will get there. Anyone who does have a strong opinion (i.e. an exact date) on the timing and the specific details is, I think, kidding themselves. Rather than trying to figure out how to figure, it is better to pay close attention to what's happening in real time and adjust your positioning accordingly. It's not like the collapse could happen next week. At least, the US$ is not going to collapse next week or even within the next 12 months (although the euro might). Some things are bound to happen well before the US$ collapses, chief among them being a huge rise in the T-Bond yield. We are not, for example, going to see the US$ collapse with the T-Bond yield at 3%, or even with the T-Bond yield at 8%. Before the US$ collapses we will see the T-Bond yield move well into double digits.

My only other piece of general advice is to not bet the ranch on a single extreme outcome. For example, don't bet everything on the idea that the US is going to experience hyperinflation in the near future. The US will eventually experience hyperinflation, but the probability of it doing so within the next two years is close to zero. As far as this year is concerned there's more chance that the US will experience genuine deflation (a decline in the supply of money) than hyperinflation, but both of these extreme outcomes have very low probabilities when taking a short or intermediate-term view.