Money

How much is this quarter worth?

In 1964 it was worth $0.25. Today, it’s worth a whole lot more. That’s because it is a magical quarter. The magic is that it maintains its purchasing power no matter how many dollars our government prints.

What do I mean by that? Before 1965, quarters were made of 90% silver and 10% copper. Now they are mostly copper with some nickel on top to make them look pretty. Today, the value of the silver content in pre-1965 quarters is determined by supply and demand in the market. And while the price may fluctuate, over time it should rise in line with other commodities due to monetary inflation (i.e. the Fed printing dollars).

For instance, in 1964, the average price for a gallon of gas was $0.30, so a quarter could buy just under 1 gallon. In 2010, the average price for a gallon of gas was $3.18 while the value of the silver in a 1964 quarter was $3.65. In other words, a 1964 quarter could buy more than a gallon of gas in 2010. So the next time you are filling up at the pump, lamenting how the price of gas has gone up, perhaps you should be complaining about how the value of the dollar has gone down. In fact, gas has gotten cheaper in real money.

So exactly how much is that quarter worth today?

The chart below shows the real time price of an ounce of silver.

To determine the value of a silver quarter simply find the price per ounce on the chart and multiply that number by 0.18 (the ounces of silver in a pre-1965 quarter).

Surprised?

That price is one indication of just how much our government has debased our currency over the last 40 years. It represents a silent theft of your purchasing power; a transfer of your hard earned paycheck and savings into the pockets of bankers and the politically connected.

Based on the actions and rhetoric of our politicians and central bankers, this ongoing destruction of the dollar is likely to accelerate over the next few years and may end in a collapse of the dollar. Unfortunately, the true nature of our money system isn’t taught in school, and most Americans will be completely surprised by how quickly a currency based on trust can disintegrate when that trust is abused.

Even wealthy Americans can be wiped out by a currency collapse if they are not prepared. The best way to protect oneself is by saving in real money- gold and silver. To find out why, keep reading below and please take some time to check out the additional resources I’ve provided. The “economy” category of this blog provides some background as well.

What is Money?

Money is simply a medium of exchange and a store of value. A distinction can be made between money and currency, in that money has intrinsic value while currency is simply a medium of exchange that can be used to purchase something of value. Take the example of a paper currency like the dollar. The paper, ink, and printing costs are insignificant relative to the cost of goods one can purchase with the bill, especially if a big number is printed on it. Contrast that with a gold coin which has value based on the properties of the metal, irrespective of the number stamped on the coin.

Throughout history, many things have served as currency- shells, spices, coins, paper bills; even cigarettes are used as currency in today’s prisons. But as currencies have come and gone, only gold and silver have stood the test of time as real money.

That’s not to say that nothing else could serve as money, or that a currency can never be sound. It’s just that throughout history, gold and silver have proven to be the best money because they satisfy important properties of good money. Money should be:

1. Portable. It should be easy to carry around, transport and store.

2. Durable. Gold and silver are virtually indestructible. A gold coin could be melted in a fire or lost at the bottom of the ocean, and the value of the gold could still be recovered.

3. Divisible.  Money should be easily divisible into equal units to accommodate a wide range of transactions.

4. Sufficiently rare. Money should be rare enough to not require a large amount to be carried around for normal transactions, yet plentiful enough so that its smallest divisible unit can accommodate very small transactions.

5. Fungible. That is, any one unit of the money should be interchangeable with any other unit. Diamonds, for example, don’t pass the fungibility test since each diamond is unique.

6. Non-essential for consumption. Oil, for example, would not make good money because it is too useful as an energy source and is thus consumed. As the important industrial uses of silver grow, silver may conflict with this requirement. However, due to its history and other desirable monetary properties, silver could function as money in a system of competing currencies.

7. Easily identifiable. Money should be easy to detect and difficult to counterfeit. The US Mint goes through great lengths to make its dollars hard to copy. Gold has unique properties that can be easily identified and tested with simple tests.

7. A store of value. This is perhaps the most important feature of sound money. A functioning economy requires that people are confident that their money will retain its value over time. 2ooo years ago, a one once gold coin could by a nice toga and a pair of sandals. Today, once ounce of gold can buy a nice suit and a pair of shoes. Contrast that with the US dollar, which has lost 96% of its value since the inception of the Federal Reserve Bank in 1914.

The paper dollars we hold in our pockets and the digital representations of dollars we store in our bank accounts do a fairly good job of satisfying the first six criteria above for money, but fall short as a store of value over time. Today’s dollar is most certainly a currency, and as I hope do demonstrate below, a bizarre and fragile one at that.

A (very) Brief History of Money

Back in the day, there was a wheat farmer who wanted fish. Unfortunately, the fisherman in his town didn’t want any wheat, so the farmer was SOL. Luckily, the berry picker did want wheat, and although the farmer was allergic to berries, he was happy to trade his wheat for berries, since he knew the fisherman had a sweet tooth and would gladly exchange fish for berries. The berries were fairly easy to carry around and most people in town would accept them in trade for goods knowing that even if they couldn’t eat all of them, they could easily trade their excess for other goods. Thus, the first money was born. (Well, something like that.)

As civilizations emerged, people began to use various commodities found in their society to facilitate trade. Roughly 4500 years ago, gold and silver began to emerge as the most commonly traded commodities for use as money. Around 650 B.C. the first gold and silver coins were minted in the ancient empire of Lydia, creating the first money that satisfied all of the seven properties listed above.

From that day forward, gold and silver, in various forms, have been money. And from that day forward, politicians and bankers have tried to cheat gold and silver to suit their needs by debasing the currency. In ancient Athens and the Roman Empire, governments did this by replacing the high value gold coins with coins made of larger and larger percentages of other metals such as copper, or by just making the coins smaller. Today, they achieve this by adding zeros to an account on a computer screen.

This pattern of money debasement leading to economic ruin has played out time and time again with fiat currencies through the ages. In his book, Guide to Investing in Gold and Silver, Michael Maloney describes this pattern as follows:

1. A sovereign state starts out with good money (i.e., money that is gold or silver, or fully backed by gold or silver).

2. As it develops economically and socially, it begings ot take on more and more economic burdens, adding layer upon layer of public works and social programs.

3. As its economic affluence grows so does its political influence, and it increases expenditures to fund a massive military.

4. Eventually it puts ts military to use, and expenditures explode.

5. To fund the war, the costliest of mankind;s endeavors, it steals the wealth of its people by replacing their money with currency that can be created in unlimited quantities. It does this either at the outbreak of the war (as in the case of World War I), during the war or wars (as in the cases of Athens and Rome), or as a perceived solution to the economic ravages of previous wars (as in the case of John Law’s France).

6. Finally, the wealth transfer caused by expansion of the currency supply is felt by the population as severe consumer price inflation, triggering a loss of faith in the currency.

7. An en masse movement out of the currency into precious metals and other tangible assets takes place, the currency collapses, and massive wealth is transferred to those who had enough foresight to accumulate gold and silver early on.

Does this pattern sound familiar? Does America seem to be following these steps? If so, how far along in the process are we? A currency collapse could never happen in America… could it?

Paper Currency

Gold and silver coins worked fairly well as money, but they were bulky to store and carry around, and were susceptible to theft. To protect their savings, people began to pay their local goldsmith a small fee to store their gold, since his vault was generally the most secure spot in town. In exchange for the gold, they were given a paper receipt or claim check for their gold. Since these receipts were easy to carry around, could be created in different denominations, and entitled the bearer of the receipt to gold in the vault, people began to trade the receipts as currency.

Fractional Reserve Banking

In addition to his coin minting business and his gold storage business, the goldsmith had a side business of lending out his own gold (usually in the form of paper gold receipts) to borrowers at an interest rate. The goldsmith soon realized that most of his gold storage customers just left their gold in his vault and rarely redeemed the receipts for gold; and if they did, it was even more rare that all of his depositors would claim their gold at the same time. So the goldsmith found he could lend out additional gold claim checks and collect interest on other people’s gold in his vault. This was clearly fraud, since the gold in the vault now had multiple claims on it, but as long not everyone tried to redeem their claims at once, the goldsmith could get away with it.

Soon, however, the people caught on. But instead of prosecuting the goldsmith, they wanted in on the action. They institutionalized the practice by creating laws that allowed the goldsmith to lend out claim checks so long as he maintained a certain percentage or “fraction” of reserves in his vaults of his and his depositors’ money. The depositors demanded to be paid interest in exchange for the use of their money, and the goldsmith in turn would charge a slightly higher interest rate to borrowers to cover his expenses and profits. And such, the beginning seeds of the modern banking system were sown.

[For a more complete description of the Allegory of the goldsmith and a great primer on how money is created today, I would highly recommend watching the “Money as Debt” video below.]

Money in America

For most of America’s history, the US dollar was backed by gold. It didn’t start out quite that way. The early American colonists used all sorts of things for currency, from Spanish silver dollar coins, to beaver pelts, to paper “bills of credit” issued by the colonies. These bills of credit were some of the first examples of fiat paper currency in the Western world, and were accepted because they could be used to pay taxes to the colonial governments. When the Revolutionary War began in 1775, the Continental Congress began issuing its own fiat paper currency known as the Continental to pay for the war. As the war costs mounted, the colonies and the Continental Congress issued more and more currency to pay for the war. By the end of the war, the Continental had lost so much of its purchasing power that it stopped circulating as currency. When people say that hyperinflation could never happen in America, bear in mind that it already has.

The founders of the newly formed United States of America learned their lesson from the hyperinflation of the colonial currencies and wrote expressly in the U.S. Constitution that states could not issue bills of credit or “make any Thing but gold and silver Coin a Tender in Payment of Debts.”

From the founding of our nation through the creation of the Federal Reserve in 1913, there were different variations of gold and silver backed money, but in general, each dollar in circulation was redeemable for gold or silver.  During that time-period, the value of the dollar was very stable and the price of goods in fact, trended gently downward, with a few blips of expensive goods during war times as shown by the chart below.

There were exceptions, such as the fiat “Greenbacks” issued by President Lincoln to pay for the Civil war. And there were some problems, such as trying to force bi-metalism with gold and silver, and runs on the banks (which operated under fractional reserve rules). In general, though, America and the world thrived under a classical gold system until WWI.

The Federal Reserve System

In the early 20th century, it was widely believed that the large New York banks, known as the money trust, were using their control of money and credit through fractional reserve banking to systematically crash the market and then buy stocks on the cheap before selling them at huge gains. In 1907, there was a major stock market and bank panic that caused Americans to demand that something be done to prevent similar panics and investigate the Money Trust.

In 1908 Congress set up a commission, led by Senator Nelson Aldrich to devise a solution. After consulting with the private central banking institutions in Europe, Senator Aldrich convened a secret meeting with the powerful New York bankers he was supposed to be investigating to devise what would eventually become our Federal Reserve system. It should come as no surprise then, that a system created by the banks and for the banks, creates huge profits for banks during boom times and bails out the banks when things go bust.

Contrary to popular belief, the Federal Reserve Bank is not a government institution, but a private corporation owned by many of the large private banks. Sure it has certain restrictions, and the Fed Chairman is nominated by the President (from a hand picked list of applicants), but it is no more “federal” than Federal Express.

With the advent of the Federal Reserve bank in 1913, the Congress gave this private central bank the power to create currency out of thin air as long as they held at least 40% of reserves in gold in their vaults. At the inception of the Fed, the dollar was redeemable for gold at the fixed price of roughly $20 for 1 ounce of gold.

When the credit bubble of the Roaring ’20s burst in 1929, foreclosures, loan defaults, bank runs and bankruptcies caused a deflationary contraction of the money supply. By 1933, one third of the currency supply had disappeared and was falling fast and as more banks failed, Americans and foreigners began withdrawing their gold from the banks. President Franklin Roosevelt passed an executive order making it illegal for U.S. citizens to own gold and requiring all U.S. citizens to sell their gold to the government for $20.67. He then revalued the currency to $35 per ounce of gold for international transactions. This was in essence a 40% default on our currency.

With Roosevelt’s dollar devaluation, foreigners saw an instant 70% increase in their purchasing power for U.S. goods, which caused gold to flow into the country in exchange for U.S. goods. During WWII, American factories supplied the world with goods and munitions as European factories were bombed, further increasing U.S. gold reserves and trade surplus. As the war was ending, the badly damaged economies of Europe needed a stable means of international trade without the fear of exchange rate swings or currency devaluations. In 1944, representatives from forty-four countries met in Bretton Woods, New Hampshire, to devise a new international monetary system. Since America now owned most of the world’s gold and had the strongest economy, they decided that all currencies would be pegged to the U.S. dollar, and the dollar would be backed by gold and redeemable by foreign central banks at $35 per ounce. The dollar was now effectively the world’s reserve currency.

Unfortunately, the Bretton Woods agreement never set a reserve ratio for how many dollars could be printed for each ounce of gold, essentially allowing the U.S. government to run large trade and budget deficits and print dollars to make up the difference. In the late 1960’s the federal spending ballooned to pay for war in Vietnam and social programs at home. The Federal Reserve inflated the money supply to finance those programs, and foreign governments began to lose faith in the dollar and demanded gold instead. Gold began pouring out of the treasury to foreign countries until in August of 1971, President Richard Nixon ended the convertibility of dollars to gold. This constituted a second default on our debt.

From that point on, the U.S. dollar was backed by nothing but the full faith and credit of the U.S. government and the Bretton Woods agreement broke down allowing foreign currencies to fluctuate without a dollar peg. For the first time in history, all of the world’s major currencies were fiat currencies which could be created at the whim of governments. If you scroll back up to the chart on the CPI and look at what happened to prices starting in 1971, you can see what happens when governments are not constrained by the discipline of a commodity backed currency.

Money = Debt

The process of how money comes into existence in the Federal Reserve system is just bizarre. When most people think of money creation, they envision the federal government printing dollars and then spending them into the economy. Not so. In reality, most of the money circulating through the economy is created by banks when they issue loans. The banks are able to conjure up this money through the magic of fractional reserve banking as I eluded to above.

It works like this: Say a bank starts with $1000 in reserves. Fractional reserve laws allow the bank to loan out 90% of that or $900 to a borrower. The borrower signs a piece of paper saying he will pay back the loan at some future date and the bank adds $900 to his electronic account. If the borrower uses the $900 to buy a used car, the person selling the car takes the $900 and deposits it back in the banking system. This $900 is now new reserves for the banks which can then lend out 90% or $810 to a new borrower. the process is repeated over and over until up to 9 times (and actually more based on today’s rules) the original $1000 has been created. All of that money was created based on the borrowers promise to pay it back with interest. All of this “checkbook money” is nothing more than debt.

The above example explains how most of the money in circulation is created based on bank reserves, but where did the original $1000 or “base money” come from? In essence, when the government needs money in addition to its tax revenue, it borrows that money by issuing Treasuries, which are simply bonds that will be payed back at some point in the future with interest. To create new money, the Federal Reserve buys the Treasuries with new dollars (a.k.a Federal Reserve Notes) that it simply invents on its balance sheet. Those new dollars are now money in the government’s bank account that can be spent into the economy. However, since the Federal Reserve now owns the government Treasuries, those Treasuries will at some point need to be paid back by the government with interest. In other words, since 1914, all U.S. dollars are created by debt.

If you’re paying close attention you may be wondering a couple things:

1. Why on earth would the Congress pay interest to a private bank that creates money out of thin air, when the congress could just create the money without having to pay interest?

2. How can the government pay back the principal plus interest when the Treasuries mature considering that the Federal Reserve only created an amount of money equal to the principal?

The answer to question one that is given by proponents of the Federal Reserve is that we need an independent central bank that is immune from political pressure to issue more money, thus keeping Congressional spending in check. The real reason is that the law was written by the very bankers who collect that interest.

The short answer to question two is that it can’t. The long answer is that it can, as long as more money is borrowed into existence to pay back the interest on the money already borrowed. What’s important in our money system is that the total debt in the system must continue to grow at a rate equal to the interest payments on the debt. The federal government is only one borrower (albeit the biggest borrower) in the entire system. The total debt market includes every person, company, and government entity who has borrowed money.

An individual borrower can pay back the principal on his loan plus interest due to the time lag he has to pay off the debt. However, it is impossible for all borrowers to pay off all debts, since there would not be enough money in existence to cover the interest. Therefore, to keep the system going, the money supply must continue to increase at an exponential rate. In a world of finite resources, an exponentially increasing debt burden must eventually collapse on itself.

Endgame

People intuitively know that you can’t borrow forever. If an individual earns $50,000 per year and spends $60,000 a year by putting the difference on his credit card, and then paying off his credit card with more credit cards, eventually, he will not be able to borrow anymore. He has a few options to prevent his credit problem from reaching this point. He can work longer to earn a bigger salary, or he can spend less by cutting back. Either way he must live below his means until he gets his credit under control. If he continues to spend more than he brings in, the rate he can borrow at will continue to rise until eventually no one will lend him money and he is forced to declare bankruptcy.

The same is true for governments. If a government borrows a lot of money to pay for a war or social programs, then it must at some point either increase tax revenues or decrease spending to pay down the debt. If it continues to spend beyond its means it will eventually face rising borrowing costs and thus more dramatic austerity. Eventually, the borrowing costs can become so onerous that no amount of economic growth and spending cuts can dig it out of its hole and the government defaults. This is the situation in Greece today.

The United States faces a similar debt situation to Greece with one major distinction: we can print our own money. Far from a panacea, this ability to print the reserve currency of the world has only given us more rope with which to hang ourselves. In essence, it has allowed us to take out more credit cards than we would normally be able to, and go much deeper into debt. So deep, in fact that we can never honestly pay back our debts. While it’s true that we can avoid technical default by printing money to pay our creditors, we will still default by paying them back with money that is worth less.

As I’ve explained in other economic posts on this blog, currency debasement and money printing is the road our government has chosen to travel down; and at this point, there is no turning back without causing a severe deflationary depression. Let’s review the final two stages in Michael Maloney’s cycle of fiat currency.

6. Finally, the wealth transfer caused by expansion of the currency supply is felt by the population as severe consumer price inflation, triggering a loss of faith in the currency.

7. An en masse movement out of the currency into precious metals and other tangible assets takes place, the currency collapses, and massive wealth is transferred to those who had enough foresight to accumulate gold and silver early on.

This cycle has repeated itself in sovereign nations throughout history and seems to playing out again right before our eyes; only this time, the whole world is involved. Will you be one of those with the foresight to accumulate gold and silver?

Resources

The information above is just the tip of the iceberg. If you’ve read this far I’m guessing you’re at least a little interested in the topic of money creation and the Federal Reserve.

The videos below are a quick, easy and entertaining way to learn some of the basics on money, the Fed, and investing in gold and silver. Beyond that, I have included a few books and web resources if you want to dig into these topics more deeply.

Money as Debt and Money as Debt II: Promises Unleashed – These videos give a great introduction to our debt based money system. While I don’t necessarily endorse the solutions provided, they are a valuable learning tool.

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The Crash Course – This video presentation by Chris Martenson dedicates several chapters to our current monetary system and does an excellent job of tying it together with the real world. Below is just one of the chapters about money, but I would highly recommend viewing the whole presentation at: www.chrismartenson.com/crashcourse The complete Crash Course will shift your entire perspective of how the world economy works and the future of our world.

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Money, Banking, and the Federal Reserve – Austrian economics teaches that sound money is the cornerstone of a sound economy. This educational video by the Mises institute is an excellent primer on, well, just what the title implies.

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Why Gold and Silver? – A conversation with Mike Maloney about money and gold, with excerpts from interviews with many leading precious metals experts. Learn why gold and silver may be the best investments you can make in the coming years.

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Gold Bullion or Cash – A great short video highlighting why owning gold is a better store of value than owning cash; especially today

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Books:
The Case Against the Fed, Murray Rothbard
Crashproof, Peter Schiff
The Creature From Jekyll Island, G. Edward Griffin
End the Fed, Ron Paul
Guide to Investing in Gold and Silver, Michael Maloney

Websites:
goldsilver.com
monex.com
europacmetals.com
silver-investor.com
gata.org
321gold.com
silverinstitute.org
gold.org
chrismartenson.com
mises.org
silverseek.com
kingworldnews.com