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Why Gold Should Be Avoided As An Investment Tool
Part 3 of 6
by James Nelson, originally published June 2007
There Is More than One Kind of Inflation!
Monetary Inflation
This lack of discipline on the part of governments leads to a very specific sort of inflation, called "monetary inflation." It works like this: Last month there were "X" number of dollars in circulation and the value of goods and services within the economy was "Y." This month, the value of the goods and services "Y" hasn't changed appreciably, but there are now "X + 3" dollars in circulation. The number of dollars has been inflated in comparison to the value of the goods and services. As a result each dollar is worth less.
Monetary inflation, over time, undermines people's confidence in the currency. As a government prints more and more dollars their real value conversely becomes less and less. Of course, it's impossible to determine exactly what the precise value of a currency is. Monetary inflation is hidden; it doesn't affect the pocket book directly. But in general terms, those paying attention know that the value of the currency is being eroded. Eventually people who are able to do so start dumping the currency in favor of another currency or other investment vehicles that are deemed more reliable. This can lead to a "crash": Suddenly and unexpectedly price inflation (that is, the cost of goods and services) can spiral out of control.
Thirty Years of Printing Money
So far this has been theoretical, but let’s put it in real terms. The following spread sheet and chart shows the Gross Federal Debt (a rough measure of how much money is being printed) and the Gross Domestic Product (a measure of the total goods and services). It covers the years 1975 through the present in 5 year increments.
|
Gross Federal Debt and |
|||
|
GDP |
Debt |
Percent |
|
|
(trillion $) |
(trillion $) |
||
|
1975 |
1.5 |
0.542 |
36% |
|
1980 |
2.7 |
0.909 |
34% |
|
1985 |
4.1 |
1.8 |
44% |
|
1990 |
5.7 |
3.2 |
56% |
|
1995 |
7.3 |
4.9 |
67% |
|
2000 |
9.6 |
5.6 |
58% |
|
2005 |
12.2 |
7.9 |
65% |
|
From David Welna, Nat’l Public Radio, March 2006 |
|||
Notice that both the debt and the G.D.P. (which is a measure of the size of the economy) are growing. The problem is that the debt is growing much faster. In 1975 it was only one-third the size of the economy, but now it has nearly doubled its size (in percentage terms) being about two-thirds the size of the economy.
It is not accidental that this chart begins in 1975. I remind you (from a few pages back) that it was 1971/72 when the United States abandoned the Breton Woods agreement. This is when we transitioned from a currency that was loosely backed by gold to a fiat currency.
With that in mind, let’s re-frame the above information in terms of the dollar. This means that in the last 30 years, the Federal government has printed about twice as many dollars as were justified by the actual goods and services produced by the nation. Said another way, about half the dollars printed aren’t backed by anything at all. And this means that in terms of goods and services, the dollar is worth about half of what it was worth when we abandoned the Breton Woods Accord.
This is the heart of monetary inflation. It’s not something we necessarily feel in our pocket books But if people who hold dollars ever decided that the money isn’t worth what everyone assumes it’s worth, it could mean that the value of the dollar could decline dramatically.
The U.S. Treasury Dept says, "The Dollar Has No Intrinsic Value."
The simple fact is that American money (which is a "fiat currency") has no value in and of itself. It's value is rooted in the good faith that people have in the government's ability to repay its debts. If that good faith is lost, the money can become worthless. The U.S. Treasury says this very plainly on their web site. The following is an exact quote from U.S. Treasury information (emphasis added):
Federal Reserve notes are not redeemable in gold, silver or any other commodity, and receive no backing by anything. This has been the case since 1933. The notes have no value for themselves, but for what they will buy. In another sense, because they are legal tender, Federal Reserve notes are "backed" by all the goods and services in the economy. (From the U.S. Treasury website.)
NEXT: The Long Term Prospects of the US Dollar.
Copyright © 2007 James E. Nelson (Just Another Jim). All Rights Reserved.
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