The U.S. Monetary System

200 Years of Monetary Systems
Based on Gold, Then Fiat Money;
Will We Return to a Gold Standard?

By Kenneth Coleman
Investment Tracker

        I believe the current global financial contraction is not a massive recession, but a global depression. I define a recession as an economy's periodic contraction caused by a central bank's excessively high key interest rates. A recession ends when the central bank lowers its key interest rate to a point that invites corporations and consumers to borrow.
        However, a depression is a global monetary problem. To have a global trading system, you must have a global monetary system that industrial nations can use to transact import and export commerce. Thus, when there is a lack of confidence in the global currency, corporations (especially multinationals) begin demanding that industrial nations return to a system of commerce that uses real money (a currency that is backed by gold and/or silver or some other scarce commodity).
        There are two types of money: commodity money (money that is backed by an actual or physical commodity, such as gold or silver) and fiat money (money that is simply backed by the authority of a government). Fiat money depends on relative scarcity, faith in its value by users, and the cost of doing business in the fiat currency (taxation).
        In the past when users of nations who were forced to resort to a fiat monetary system lost faith in that system, they always demanded payment in real money. During the past 100 years of U.S. monetary history, the U.S. fiat monetary system has failed three times with each failure resulting in a depression. The depression occurred when the global currency used to transact worldwide trade grew scarce.
        A depression ends when the world's industrial nations join to form a new monetary system. Historically, the U.S. has rotated its monetary systems between a real money system and a fiat system. So, what are the strengths and weaknesses of each type of monetary system?
        Fiat monetary systems have no restraint on the creation of paper money. Unlimited credit creation occurs during periods when governments (or their central banks) keep their key interest rates too low. These fiat credit explosions have always created massive bubbles in commodities, real estate, and stocks.
        Although all of these result in bubbles, only one will result in a massive bubble. However, these bubbles are not limited to traditional investments. Even esoteric investments, such as tulip bulbs, have ended in an investment bubble.
        There is no consensus by most conservative economists that longer-term fiat monetary induced gains tend to inflict much more pain on a nation and its citizens during the following contraction that it gained from the credit bubble expansion. In order to realize this fact, you need to look no further than the current credit contraction. It pains me to say we could be much closer to the beginning of the current credit crisis than the end.
       If credit bubbles have occurred throughout modern monetary history (going as far back as the Dutch tulip mania bubble in 1637), then why has the U.S. government resorted to fiat money five times during its 233 year history? The answer: it has turned to fiat money out of necessity. In the majority of cases, it happened when our government faced huge excessive debt; when our government could no longer pay its debt in gold or silver (real money). The alternative would have been for our government to default on its debt. That would have been tantamount to national suicide.
        The last nation to resort to national debt default, thus national suicide, was Germany. As the Great Depression grew severe in 1931, Germany repudiated its debt. This was the trigger that later rose Adolph Hitler to power. Hitler's message: Jewish bankers sold out the German people after World War I and have pushed them into national bankruptcy and disgrace. The West's press in the 1930s ignored this very obvious threat to Germany's Jewish population. No one can argue that the emergence of Hitler's National Socialist German Worker's Party was one of the most dreadful consequences of the collapse of the world's real monetary system in 1931.
        No review of monetary history would be acceptable without mention of what happens to a fiat currency if left in place too long. A fiat currency creates its own destruction. The terminal stage of any fiat currency is hyperinflation. As more and more money is printed to bail out failing banks and corporations, the nation becomes flooded with money. Because the value of fiat money depends on the amount that is created, its value drops as supply increases.
        The Federal Reserve ceased to provide the public its money supply growth data since 2006. Consequently, investors and analysts were forced to rely on educated guesses as to how much money the banks were creating. All confidence in our fiat monetary system will be lost at some point during the printing of massive amounts of money. When this happens, fiat money essentially becomes worthless regardless of how scarce the supply becomes.
       Fiat money has failed time and time again over its 3,000-year history. Every time it failed it was replaced by gold. As mentioned, the U.S. has used a fiat money system on a number of occasions for about 200 years. So, how has it managed to keep its fiat system from turning terminal?
        The U.S. has managed to keep the dollar relatively valued because every time a fiat dollar was in danger of hyperinflation it shifted its fiat monetary system to a gold system.
For the sake of space, let us skip the continental fiat dollar (used during the American Revolutionary War to pay down debt). Let us also skip the Federal Monetary System that defined the value of the dollar by statue as a specific weight of gold.

The Floating Fiat Currency of 1862-1879
(duration: 17 years)

        We will begin with the greenbacks of 1862, printed to pay for the enormous cost of the Civil War that begun a year earlier.

The Fixed Gold Standard of 1880-1914
(duration: 34 years)

        The U.S. dollar was pegged directly to the set value of gold. This resulted in domestic price stability and virtually no currency inflation (unwanted growth). This period became known as the Classic Gold System (a period of unprecedented U.S. economic growth; a period all conservatives dream will return).

The Floating Fiat Currency of 1915-1925
(duration: 10 years)

        In order to pay for World War I, member nations had to abandon the Fixed Gold Standard. Fiat money allowed them to print the money needed to fund a world war.

The Fixed Gold Standard of 1926-1931
(duration: 5 years)

       The Gold Exchange Standard (as it was to become) called for member nations to peg their currencies to the British pound and the U.S. dollar. The U.S. had a limited number of dollars in circulation, so the burden for managing the monetary system fell on Great Britain. The U.S. attempted to increase the number of dollars it created by keeping its key interest rates extremely low. This, of course, led to a bubble economy in stocks. When other member nations began losing confidence in this system, they started cashing their dollars and pounds for gold. This forced Great Britain to terminate the Gold Exchange Standard.

The Floating Fiat Currency of 1931-1945
(duration: 14 years)

        National fiat currencies took the place of the gold-backed British pound and U.S. dollar. This led to a massive global monetary and debt explosion. The greatest evil to come of this was the murderous Nazi regime and World War II as a result of the gold system collapse.

The Fixed Gold Exchange System of 1945-1965
(duration: 20 years)

        At the end of World War II, the major Allied nations met at Bretton Woods, New Hampshire, and essentially re-established the failed Gold Exchange System of 1926-1931. The new Gold Exchange System was similar to the first and involved the same nations (the U.S. and Great Britain). The U.S. dollar and British pound sterling were again the world's trading and reserve currencies. To show their gratitude for being freed from the grasp of Nazi Germany, Allied European member nations again took advantage of Great Britain's' weakened economy and currency, thus again causing the pound sterling to collapse. This was the beginning of the end for the original Bretton Woods system.

The Revised Fixed Gold Standard of 1963-1968
(duration: 5 years)

        During the next three years, member nations tried to salvage the failed monetary system. It appears the conditions for the newly restored monetary system were partially fiat and partially gold standard. One might compare this to trying to be a little pregnant. In 1963, the most harmful condition added to the gold standard was the new federal reserve notes (dollars could no longer be exchanged for "lawful money").
        The next blow against hard money came when the silver dollar was removed from circulation. Silver was eliminated from all coins by 1965 with the exception of the Kennedy half dollar (whose silver content was reduced to 40 percent). The U.S. citizen, therefore, was left to the mercy of his/her spend and borrow government (the Johnson Administration). While U.S. citizens were left to suffer the pain of massive inflation, member nations of the revised Gold Exchange System were well protected. These nations could still trade dollars for gold at a set rate of $35 per ounce of gold.
        The newly revised Bretton Woods system, however, had a major flaw. It made no provision for monetary and price inflation. The value of gold had been set in stone; no matter its price on the black market, it could still be obtained by member nations at $35 per ounce of gold in a dollar exchange.
        France's Finance Minister at the time warned then President John F. Kennedy of the danger in not having an inflation escalation clause that would increase the value of gold if the need were to arise. Kennedy, and later Lyndon B. Johnson, ignored this prescience advice. As a result, over the next 20 years, their arrogance and/or ignorance eventually brought down the Johnson presidency and forced the U.S. to sacrifice its massive wealth and industrial might.

LBJ's War on Gold

       In June 1968, President Johnson issued a proclamation that Federal Reserve silver certificate notes could no longer be traded for silver dollars, ending the era of hard money. The final years of the revised Gold Exchange System became known as Johnson's War on Gold.
        The U.S. government used the gold reserves in Fort Knox in a futile attempt to keep the price of gold at $35 per ounce. It never again dawned on these idiots that gold was the benchmark of dollar value. To give gold away at what amounted to a discounted price was nonetheless counterproductive. After a short time Johnson's War on Gold forced gold's price to move higher on the black market.
In short, the U.S. government sold its gold at a large discount price to support the dollar with an estimated loss of two-thirds of its gold reserves.

The fixed Dollar Standard of 1971-1973
(duration: 2.5 years)

        In 1971, a few years after Johnson was driven from office, President Richard Nixon was informed that the U.S. no longer had the gold to operate the Gold Exchange System. In August 1971, Nixon closed the gold window drain. However, it does not end there. The sell out of our nation's gold reserves went even further.
        The Fixed Dollar Standard was enacted. It pegged the world's currencies to the value of the dollar rather than gold. In order to prevent dollar value from falling rapidly, Nixon set price and wage controls. Nixon continued Johnson's War on Gold (the Nixon Administration sold gold on a regular basis on the open market to keep its price down and dollar value stable).

The Floating Value Fiat Currency System of 1973-Present
(duration: 36 years to date)

        Nixon's policy culminated in a massive 1973 recession, which could have grown much nastier than it did had G8 industrial nations refused to help the U.S. establish the current floating fiat currency system. This system has been revised several times since 1973.
        These revisions have served to prolong the fiat money rip-off. Accordingly, this fiat money system has lasted over twice as long as any bogus dollar system in the history of our nation, providing bogus money twice the time to destroy the U.S. economy and the wealth of its people.
        Most Americans, regardless of their political affiliation, are anxiously waiting to see how another charismatic Democrat leader fares in bringing our nation out of recession. What most people do not realize, however, is that we are not in a recession. We are in a global depression.
        So far, we have had four charismatic Democrat leaders attempt to pull our economy out of a depression (Franklin D. Roosevelt, John F. Kennedy, Lyndon B. Johnson, and now Barack H. Obama). Every one of these presidents turned to socialism and massive deficit spending to stimulate the economy. So far, none of them have been successful. After 3,000 years of on and off again fiat money systems (all of which failed), why then should we expect it to succeed this time around?
        Circumstances are very different this time (a statement that has all too often been the kiss of death for many analysts). When investors heard that statement, more often than not they headed for the doors.
       It used to be that the more things changed, the more they stayed the same. Space and time does not allow me to explain what I mean, but two things are very different from anything that has happened throughout our nations roughly 200-year history of fiat money (a short-time compared to the roughly 3,000 year history of fiat money).
        As I said, this time may be different. That which may be different gives G20 industrial nations a small chance to resurrect the current failing bogus money system. I expect the resurrection to last only to buy more time (perhaps 10 to 15 more years) before the introduction of another gold standard system.
        It is a long shot, but it is workable. That is why President Obama appointed four former central bankers in an attempt to revise the current failing fiat monetary system. G20 meets again April 2, but it may be too early for anything meaningful to come of this. The April Investment Tracker, newsletter will cover G20's chances for success and the two new tools it has to work with (two tools that no one else in the 3,000 years of fiat money history has had to use to their advantage.
       Editor's Note: Kenneth Coleman is editor of Kenneth Coleman's Investment Tracker, 4805 Courageous Ln., Carlsbad, CA 92008, 1 year, 12 issues, $139, which specializes in Domestic and Global Money Flow Analysis. Mr. Coleman brings to market analysis a unique perspective. Experience has taught him what drives stocks, bond and commodity market, thus the economy. It's money. As a result, Mr. Coleman has developed a revolutionary strategy for timing the markets at home and abroad. This strategy has had unparalleled success in determining what is profitable to buy or sell. Visit the website at www.theinvestmenttracker.com for more information.
        Listen to Ken Coleman on George Gamble's Radio Show, www.gemradio.net, Gem Radio archives (KCOE show) KCOE Money Radio, Southern California area, Tuesdays.