The Financial Clan
Money can’t buy happiness, but it can certainly ruin it if not managed properly. It forms an integral part of our daily lives, limits what we can and cannot do, and as such it should be a part of any family’s plan. As the name of the blog suggests, and as many people know, I’m a contrarian when it comes to many things, tend to question everything, and money is no exception. So, as my first post in the Financial Clan section of this blog I will aim to provide you an overview of what drives my current understanding of the world from a economic perspective.
As a disclaimer: I have no crystal ball, can’t see the future, and am only one man with his own set of opinions. I don’t expect that you’ll agree with much of what I write (as most people don’t), but if you can’t answer the simple question of “Where does my money come from?” – and by that I don’t mean “Who cuts my paycheck?” – but if you don’t actually understand where money comes from and how it works, then you owe it to yourself to read this article in full.
In 2012 I had the pleasure of serving as a delegate to the Republican National Convention in order to support the ideas promoted by Ron Paul. I met some amazing people and heard frequent reference to concepts such as fractional reserve banking, bitcoin, monetary policy, and gold as currency. However, even with it all right in front of my face I was admittedly only interested in things like ending wars, increasing individual liberties, and affecting a more inclusive election process.
I was sorely disappointed in the entire scene and quickly realized how rigged the entire political system is (maybe a subject for another post), but what I have since come to realize is that although it’s nearly impossible to change the system, it is possible to change your own life. Believing that politicians will protect you and your family is a false hope. Rather, a prudent man should just do it himself.
In 2013 I began digging deeper into understanding the machine that is the world monetary system. I came across Chris Martenson, creator of PeakProsperity.com, who was able to weave it together for me in a way that made sense (more on that in Part 2). From there on I felt my eyes were no longer shielded by blinders and that I had the understanding I needed to really understand the economic world around me.
So although there have been many people I’ve read and followed, a particular thank you to Ron Paul and Chris Martenson for opening my eyes to a whole new world. I hope this article series can do the topic justice and point others to a better understanding.
The History of Modern Currency
It’s a fool’s errand to try and understand the modern world or its future without first understanding its past. They say history doesn’t always repeat itself, but that it certainly rhymes. Therefore it’s key to see where humans have been before guessing at where they’re headed. The best, easiest-to-understand explanation of this history I’ve been able to find was put out by Mike Maloney, creator of GoldSilver.com. Therefore, Part 1 of my Economic Primer will essentially be an overview of this excellent video series. My words won’t do it justice though, so best that you actually do take the time to watch the videos. And if you really are too lazy to watch all the videos, please at least watch the fourth – this one really is a must.
Before you begin, I would like to outline two key concepts for you to bear in mind while you’re watching these videos:
- Currency is simply a claim on something of value. It has no value itself.
- Every accounting transaction is two-sided. If one person is buying, another is selling. Therefore, wealth is never destroyed – it is merely transferred from one person to another.
With those two basic concepts laid out, I invite you to watch the first episode of Mike Maloney’s Hidden Secrets of Money. In this episode, you will learn the difference between money and currency. The key takeaway is that currency is a medium of exchange, a unit of account, portable, durable, divisible, and fungible, but that it is not a store of value in and of itself. Money, on the other hand, is all of these things as well a store of value on its own. A dollar bill today may buy you something you want, but in another 100 years it may not. In fact, all fiat currencies (paper-based currencies) throughout all of history have eventually lost their entire value. This is a 100% failure rate. Anybody who assumes the dollar can never fail would be ignoring thousands of years of history suggesting otherwise.
Episode 2 goes into further detail on the history of the US monetary system. It’s important that you understand that fiat currency derives its value directly from people’s confidence in the system. The US dollar will buy you goods only because people think it’s worth something. In reality, it’s worth nothing. However, this wasn’t always the case. At the start of the 20th century, you could take $20 to any bank and redeem it for 1 ounce of gold. This was possible because for every 20 dollars in circulation there was 1 ounce of gold in the vault, otherwise known as a gold standard (100% gold backing). A gold standard prevents banks from printing money because if they did, then they would be forced to purchase gold. When the Federal Reserve Bank was created in 1913, the US moved from a gold standard to a gold exchange standard (partial gold backing) under which banks only kept 40% gold reserves (1 ounce of gold held in vaults for every 50 dollars in circulation). In 1933, to pay down government debt, FDR ordered the confiscation of privately held gold and subsequently altered the conversion rate to $35, which instantly devalued the purchasing power of each dollar by 75% and effectively transferred a massive amount of wealth from citizens to government.
By the end of WWII the US had accumulated two thirds of all the world’s gold by selling food and consumer goods to Europe in exchange for gold while they were busy building bombs (the US only got directly involved towards the end of the war). At this point, in 1944, because nobody else had enough gold left to support their currencies, the Bretton Woods system was created and the world was put onto the dollar standard (currencies backed by the US dollar). The US dollar was still backed by gold redeemable at $35 per ounce, but instead of banks being required to hold 40% of their reserves in gold, they weren’t required to hold any! Naturally, the government started printing currency because there was no requirement to offset the paper currency with gold. Eventually, when the rest of the world powers started to question whether or not there was enough gold to cover all the printed dollars floating around, they started to send back their dollars and redeem them for gold. This led to a quick 50% depletion in the US gold supply. To stop the run on Fort Knox, Nixon officially ended the US dollar’s convertibility to gold in 1971. Since that time, it has been a fully fiat currency.
Think of gold as a governor on the printing press. Well there hasn’t been a governor on the printing press since 1944, meaning the value of each dollar is held up only by people’s confidence in the system. Were this confidence to disappear, so would the value of your currency. If you think it isn’t possible for our monetary system to fail or change, you need only look at the past 100 years. It happened in 1913, again in 1933, again in 1944, again in 1971, and it can and will happen again. Through each of these transitions, currency lost value – it never gained it. The next time will be no different.
The Future of the Monetary System
Episode 3 shifts from history into present-day. It’s important to realize the reasons the US dollar is king right now:
- It’s the world’s reserve currency and primary means of settling international trade.
- Oil is priced in dollars (buyers of oil must first buy dollars).
Because the US dollar is the world’s reserve currency, over half of all dollars in existence are actually overseas in foreign bank accounts. This means that if the world were ever to start ditching the dollar, then all that currency would come home to the US and flood the system, shocking it into a state of high inflation (expansion of the money supply). Many say this can’t happen, but the truth is that it already is. Since the start of the 21st century Iraq, Iran, and Libya have started selling their oil in exchange for euros or gold instead of dollars. Funny coincidence that the US found reasons to intervene militarily in these countries. Several countries, most notably Russia and China, have been signing bilateral trade agreements so they can trade goods between themselves without first requiring dollars. Additionally, Russia and China have been overtly (Russia) or covertly (China) buying mass quantities of gold in order to hedge or replace their US dollar reserves with something of real value. During WWI and WWII we saw a huge flow of gold from Europe to the US, which set the stage for US dominance. Today, there is a massive flow of gold from West to East. Russia and China are taking the lion’s share, but they’re not the only ones losing confidence in the system. Germany and the Netherlands have both demanded repatriation of their gold being held in Fort Knox. Germany hasn’t gotten theirs yet, prompting many to question whether or not it even still exists. Citizens in Austria have been asking for similar action, and a referendum in Switzerland was recently brought forth to move the country back onto a gold standard, although it failed to pass.
So what does the future bring? If history is any indication, governments won’t proactively change the system because big change is historically only borne out of big crisis. What’s more likely is that the governments of the world will keep doing what they’re doing until it falls apart, and then they will be forced into another solution. During crises of the past, gold has always done an accounting of the paper money in circulation. In 1933 gold went from $20 to $35 (75% increase) and in the years following 1971 it went to over $800 (a 24-fold increase) despite experts in the 70’s predicting the price of gold would go down. Today gold is well over $1,000, but a true accounting of the system has not yet happened. Some people predict gold would have to go as high as $26,000 to account for all the dollars in circulation. Now this assumes that the money supply stays as it is. If we were to have deflation (a shrinkage in the money supply), then rather than gold going up to meet money, money would come down to meet gold. In my opinion this is more likely in the short-term since there is so much bad debt out there and when people default on their loans or go bankrupt then the credit system contracts and money essentially disappears. Even so, thanks to the Federal Reserve’s massive quantitative easing (money-printing), there is so much money in existence that gold would still need to go up in order to account for the imbalance, even if we experienced deflation.
The key point to take away from this is that when people say the value of gold is going up, what they’re really saying is that the value of the dollar is going down. At today’s gold prices, one could safely argue that the value of the US dollar has decreased by over 98% since the Fed came into existence in 1913. So, is it really that hard to believe that it could make it all the way to 100%?
The Giant Ponzi Scheme
Episode 4 is a must-watch, and you may have to watch it at least a couple times in order to start to understand (I know I certainly did). The fractional reserve banking system we live under is quite possibly the biggest fraud of all time. It literally creates money out of thin air by slowly robbing the many and enriching the few. Here is how the system works in 7 steps:
- Politicians make promises the government can’t afford, so the treasury issues bonds (a glorified IOU). These bonds are then sold to banks, who make money off the interest, and the treasury gets the cash.
- The banks then sell the bonds to the Federal Reserve, who pays for them by printing money out of thin air (yes, that’s right). This turns the treasury bond into cash that the bank can then spend as it sees fit.
- The government spends the money from Step 1 on social programs and military, part of which goes to government employees who then deposit the money into their bank accounts.
- In a fractional reserve banking system, banks are only required to keep a fraction of your deposit on hand. These percentages may be as high as 10% or as low as 0%. The remainder (90-100% of it) is loaned out to other people for homes, cars, or whatever so that the bank can make money off the interest. Using the example of a $100 deposit at a bank that’s required to keep 10% reserves, the bank lends out $90 of the $100. That $90 then gets deposited in somebody else’s bank, who lends out another 90%, or $81. Under this example, the process repeats and repeats until the original $100 turns into $1,000 of currency! The only way this system doesn’t fail is that it relies on the assumption that not everybody will ask for their money all at the same time (called a bank run). If this were to happen, the bank would go bankrupt and the depositors/you wouldn’t get their money back. At the end of the day, a staggering 92-96% of all money in existence is created by the banking system, not by the government!
- The government then taxes earnings of hard-working people like you and me to pay the interest on all the loans the government took out in Step 1. Coincidentally (or perhaps not so coincidentally) the US Constitution was amended to allow for an income tax in the same exact year the Federal Reserve was created. Prior to that, no income tax was ever required in the US.
- Because every single dollar is loaned into existence, this means the entire system can only function by continuously taking out more debt. This is why the debt ceiling is raised over and over again. If we were to pay off every loan in existence, there would literally be no more currency left and the system would collapse. This is the #1 reason why banks want inflation, because deflation (which is good for everybody else because prices come down as a result) would eventually destroy the entire system.
- Finally, the Federal Reserve Bank, which actually isn’t a branch of the government but is a privately owned bank authorized by the government to print money, issues a 6% dividend payment to its owners on all the money it makes off of this entire process, all while the entire country and everyone in it goes deeper and deeper into debt.
The bottom line is that this system was designed by bankers to benefit bankers. They make money in Step 2 when they sell treasury bonds to the Fed, they make money again in Step 4 every time money is deposited into individual accounts, and they make money again in Step 7 when they’re paid dividends for all the profits they made in Steps 2 and 4! In each of these steps it’s the public (you and I) who are paying the banks, either directly or indirectly. What’s worse is that we’re taxed on our earnings, and what’s even worse is that because the fractional reserve banking system continuously expands the money supply, this causes the price of all goods to go up and up so that over time things become more expensive and the purchasing power of each and every dollar we earn goes down and down and down. This is why over the decades families have moved from only needing one person to work, to needing both parents to work, to now needing both parents to work multiple jobs just to stay afloat. Income does not keep up with inflation, and this “hidden tax” is the biggest of all of them.
You can find episode 5 by clicking here, but it’s probably unnecessary for purposes of this overview. If you’re into the videos, though, I recommend you watch the fifth and last episode.
Fractional reserve banking has been around for so long now that people take it for granted as just “the way things are” and never think to question whether or not it’s the right way of doing things. The truth of the matter is that the banking system as we know it is responsible for much of the pain people feel in their daily lives today. People assume their money is safe in a bank, but don’t realize that at least 90% of it has already been loaned out to others. Most people think something of value actually backs the dollars they earn, but fail to realize it’s just paper or digital numbers on a screen that could become worthless tomorrow if the world were to change. Many people laugh about national debt and don’t see it as something that affects their real lives, but they don’t realize that each and every person has a share in national debt that must be repaid and that repayment will come from average Joes like me and you. Most people think that the US dollar could never collapse because it’s iron-clad. This is the hubris in its worst form.
Now, you may think the whole point of this is to get you to want to buy gold. Not true. The point of this is to get you to question what you think is the right thing to do. Is holding all of your money in a bank the right thing to do simply because that’s what everybody does? Is holding all of your money in US dollars the right thing to do simply because you live in the United States? Is gold something to be avoided because somebody on CNBC told you it’s a volatile asset class? Are stocks, mutual funds, and 401(k)’s the best way to grow your money because that’s what your successful uncle tells you to do?
I once watched an interview with Jim Rogers, a famous investor, who said that every time he took somebody else’s financial advise he always lost. Do yourself a favor: educate yourself; start questioning the world around you. It may just lead you down a road you didn’t expect. And, as if I should even have to say it: don’t trust the government; trust yourself.