Tuesday, December 9, 2008

There and Back Again ... How the world went from Gold to paper and why it will go back to gold ....

For THOUSANDS of years, much of the world had a single currency: gold. Gold was used as currency and to settle debts between nations. Paper currencies originated as warehouse certificates for gold and its cousin, silver.

However, that all changed in 1933, when President Roosevelt ordered all U.S. citizens to turn in their gold and silver to the government, under threat of a $100,000 fine and ten years in prison. In effect, Roosevelt seized all of the gold in America (except for rare coins, which were exempted), and for the next 41 years it was a crime for private citizens to own gold.

Despite this outrageous confiscation, nations continued to settle their debts with gold. That also changed, following World War II, when a new system, known as the Bretton Woods System (named after the town where the conference was held) was created.

Under Bretton Woods, the U.S. dollar was designated as the world's reserve currency, replacing gold. A system of fixed exchange rates between currencies was created. Only the dollar was convertible to gold, and only by foreign central banks. Other currencies could be converted to dollars at fixed rates. Because foreign currencies fluctuated in value against each other, in practice exchange rates had to be continually adjusted.

Initially, European countries experienced a serious "dollar shortage," and found it difficult to build up dollar reserves. Economist Henry Hazlitt argued that the problem was that European currencies were initially overvalued and the dollar undervalued. But rather than adjust the exchange rates, the U.S. instead flooded Europe with dollars (at U.S. taxpayer expense) in the form of foreign aid and loans.

So the Bretton Woods system ended up rewarding countries that depreciated their currencies. The result was global inflation on a massive scale. At one point, a 4 x 8 plot in downtown Tokyo – the size of a dining room table – cost US$1 million.

After a flood tide of inevitable devaluations, the situation was reversed, and dollars became overvalued. This enabled America to import more than it exported, paying for ever- growing imports with treasury securities created out of nothing.

As Richard Duncan explains in his recent book, The Dollar Crisis: Causes, Consequences, Cure, 'Under this arrangement, Americans are now freed from the ponderous burden of saving and the onerous requirement of first producing in order to later consume. Their consumption is offset by a growing indebtedness of the private sector and the Fed to foreigners. This state of affairs is unsustainable, and will come to an end with a deep fall in the exchange rate of the dollar relative to other currencies.'

"It is only a matter of time before the United States will not be creditworthy."

In the meantime, we have the bizarre situation in which it has been in the short-term interest of the U.S. government to keep the dollar weak, so that Americans can consume ever more without saving, thanks to foreigners buying our debt. At the same time, it has been in the interest of China, Japan and other governments to buy our debt to keep their own currency weak and their products cheap, enabling Americans to buy lots of them creating booming economies. But its all an illusion.

As Duncan explains, "In 2001, Chinas surplus with the US was equal to 7% of China's GDP. China's GDP growth that year was 8%. Without its trade surplus with the US, China's economy would have grown at a much slower pace – if at all." In 2003, the US account deficit "was the equivalent of almost 2% of global GDP. To put that into perspective, global GDP grew by less than 2% last year. So were it not for the US deficit, it is quite likely that the global economy would have actually contracted."

It will get worse ...

The world will do one of two things .... convince the world a fiat money system like we have had the last 100 years really is great even though its backed by nothing and we "the world" fall for it again ... or the new world RESERVE CURRANCY ( not the US dollar this time ) will be BACKED BY GOLD....

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