Surging Gold Prices Reveals Strain In The US Dollar Standard-Paper Money System

Tocqueville Asset Management LP’s John Hathaway poignantly writes:

The world’s monetary system is in the process of melting down. We have entered the endgame for the dollar as the dominant reserve currency, but most investors and policy makers are unaware of the implications.

The only questions are how long the denouement of the dollar reserve system will last, and how much more damage will be inflicted by new rounds of quantitative easing or more radical monetary measures to prop up the system.

Whether prolonged or sudden, the transition to a stable monetary system will become possible only when the shortcomings of the status quo become unbearable. Such a transition is, by definition, nonlinear. So central-bank soothsaying based on the extrapolation of historical data and the repetition of conventional wisdom offers no guidance on what lies ahead.

History has shown that paper money system don’t last long.

The only exception is that of the medieval Chinese experience which reportedly lasted 600 years. But the historical account of this isn’t certain: wikipedia says it was during the Song Dynasty, the Buttonwood’s Blog at the Economist says it was during Emperor Tsung while Dollardaze.org’s Mike Hewitt says this was during the Tang dynasty.

Meanwhile Murray Rothbard argued that the first paper money in the US was issued by the colonial government of Massachusetts in 1690.

Nevertheless Dollardaze’s Mike Hewitt examined 775 world currencies which includes the 176 in circulation (as of 2009) and 599 not in circulation, and found that

-the “median age for all existing currencies in circulation is only 39 years” and

-that the extinction of currencies had primarily been through acts of war and hyperinflation.

Incidentally and ironically, the US dollar standard since 1971 is 39 years old and seems to feel the same strain from old political habits.

Yet the attraction of the paper money system is that it allows government to pursue its political agenda via unsustainable free lunch policies.

As Murray Rothbard wrote in Mystery of Banking,

The inventions of paper and printing gave enterprising governments, always looking for new sources of revenue, an “Open Sesame” to previously unimagined sources of wealth. The kings had long since granted to themselves the monopoly of minting coins in their kingdoms, calling such a monopoly crucial to their “sovereignty,” and then charging high seigniorage prices for coining gold or silver bullion. But this was piddling, and occasional debasements were not fast enough for the kings’ insatiable need for revenue. But if the kings could obtain a monopoly right to print paper tickets, and call them the equivalent of gold coins, then there was an unlimited potential for acquiring wealth. In short, if the king could become a legalized monopoly counterfeiter, and simply issue “gold coins” by printing paper tickets with the same names on them, the king could inflate the money supply
indefinitely and pay for his unlimited needs.

Eventually, as always, monetary debasement gets abused and suffers from rampant inflation or at worst hyperinflation. And this will require either massive reform or a new currency system.

The current US dollar standard paper money system seems to be in a no different path from its forbears, as free lunch and mercantilist policies are being subtly pursued through global currency debasement.

Some call this the “currency wars”. I call this cycle the Mises moment.

And rampaging gold prices priced in every major currency (US dollar, Euro, Yen, Pounds, Canadian Loonie, Aussie Dollar, Indian Rupee, South African Rand and Gold in G5 index) seems to be saying this for quite sometime—the endgame could be near.

Charts from Gold.org (as of October 25, 2010)

For the “gold is barbaric metal” camp, paper money will reign forever even when unsupported by history and economic laws for the simple reason of dogmatic belief over free lunch politics.

But as Professor Ludwig von Mises once wrote,

The return to gold does not depend on the fulfillment of some material condition. It is an ideological problem. It presupposes only one thing: the abandonment of the illusion that increasing the quantity of money creates prosperity.

Unfortunately, anything unsustainable won’t last. And Voltaire would be validated anew, paper money eventually returns to its intrinsic value—zero.