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May 27, 2004

Gold vs. Fiat: Demanding A Divorce!
by Alex Wallenwein

The age-old "marriage" between gold and fiat is in the process of being dissolved.

The part of this that still is news to many gold bugs - even though the idea has been bandied about for years now - is the fact that gold has won friends (well ... I won't go that far; let's call them 'supporters') even within the fiat camp.

These supporters understand that this shotgun wedding wasn't in anyone's best long-term interest, really - including their own. Rather, they see that it constitutes the epitome of a failed experiment, a disastrous boondoggle, in fact.

To understand who or what is being "divorced" from what here, we first need to understand the nature of this (un)civil union. At first blush, a reader might think: "Hey, this has already happened when Nixon severed the last connection between the dollar and gold, hasn't it?"

Not so.

"Severing the last connection" is a horrible misnomer, 'cause that ain't really what happened.

Taken Hostage

When Nixon did what so many consider his "dirty deed" back in 1971, he didn't really file for "divorce" between the dollar and gold. He forced a sort of "de facto separation" and at the same time held gold hostage to the dollar's fortunes, locking it away in chains in the Treasury's legislative value-prison.

When Nixon refused to observe the US' legal obligation to exchange gold for dollars at the then prevalent official price of $35.00 per ounce, he only took the dollar off the international gold exchange standard. Nixon did not take gold off the de facto dollar-standard he thereby established.

What I mean by that is: although Nixon refused to ship gold to foreign nations upon their demand, he did not totally rescind the legislatively fixed, official dollar-gold price. That means the US Treasury continued to value the public's gold stock at the now effectively useless legislatively fixed price ratio (then $35.00 per ounce, today at $41.222 per ounce).

Nixon's reasons for doing that are somewhat unclear, and we are left to idle speculation. Maybe he just forgot?

One could argue that it doesn't matter one whit why he did this because the official dollar price of gold is obviously not being observed by anyone in the world other than the US Treasury's bean counters. That, of course, would be partially correct.

'As Good As Gold'??

However, what is clear as day is that the dollar has tried to replace gold in the minds of the world as the ultimate standard (and keeper) of value. The dollar has tried to be "as good as gold", with the implied message that it's safe to save unbacked fiat dollars, just like it was safe to save gold before then (for the world, anyway. Americans were not yet allowed to own gold again until 1975).

So, in essence, the US needed to convince the world that gold was worth little, and the dollar was worth much. What better symbolic way to do this than to show the world how little the US valued gold by keeping the "official" price at $35.00 while allowing the market price to fluctuate? Besides, I'll bet you that Nixon and his cronies in their wildest dreams never thought gold would go anywhere near $800 - and it didn't, for almost a decade afterwards.

What is equally clear is that the dollar did in fact function as a gold-substitute ever since. Maybe not that well, but it did, nevertheless. Nations used it as their currency reserve. Nations, corporations, and individuals used it in international trade settlement. People in third-world and communist countries saved it to hedge against their own currencies' decline. Oil was bought and sold in dollars. The entire world learned to revolve around the dollar, and the dollar alone.

Meanwhile, gold was kept a symbolic hostage in the US' legislative value-basement.

If old-time hard money thought was correct, the world would have figured out that fiat cannot last and would have been reluctant to use it, but this did not happen. Demand for fiat remained high even after the market last vestige of gold-convertibility was severed.

Now the financial leaders of at least part of the world appear to have recognized that fiat money is here to stay, but that gold cannot be "suppressed" forever without bringing the entire wold financial structure to an untimely demise.

In other words, they realized that the political, economic, and other costs of keeping up the illusion of the dollar's store-of-value function are too high and continue to rise as time goes on. Never has this been more clear than today, when one looks at the unbelievable derivatives tower that has been built on the dollar's back to hedge against any declines in the dollar's (and in the US economy's) fortunes.

Divorced - But Still 'Friends'

So, in essence, the world's nations and their citizens want to be able to save something other than the dollar, something that has great value and that doesn't lose that value - like gold.

At the same time, however, they want to be able to use fiat in order to trade their worldly things, because it's so convenient and so easily manipulated.

Naturally, the US has the most to lose in such an arrangement. What it stands to lose is its current privilege to simply loan into existence whatever currency requirements there are for the goods it wants from the world. That explains why the US is fighting this trend tooth and nail.

What the world (outside the US) appears to be moving towards is an arrangement where cash will be used for spending, while gold will be used for saving.

What needs to happen for this to occur is expressed in the title of this article: gold needs to petition the court of high finance and the jury of the public for a divorce from fiat. In other words, gold needs to be totally disentangled from all officially decreed and controlled national currency involvement in terms of any fixed fiat to gold price relationship.

Nothing else will do the trick.

Why not? Because we have already seen what happens to a gold standard when the government that decreed it gets into trouble.

No More Gold Standards

Every time a war was fought in the twentieth century, and more money was required to pay for it than the economy would produce, governments conveniently got off the gold standard to 'sock it' to their citizens in the name of national defense and public policy. Those governments cranked up the currency printing presses and ran them until they quit to allow them to deficit-spend their way out of the war debt.

You can argue until you're blue in your face that this should not be allowed to happen, that it's wrong, unconstitutional, etc. and that a constitutional amendment should be passed to prevent such a thing in future.

Good luck!!

You are not going to get 'the powers' to do anything unless it either adds to their power, or at the very least serves to preserve their power in the face of an oncoming calamity.

And that is the point where some of the world's money powers have pricked up their ears and started to listen to the tolling of the golden bell.

They are not stupid or inept, by any means. They are extremely bright - they just happen to be wrong most of the time. Their ineptness lies not in their lack of intelligence, but in their excess of intelligence. It's arrogance that nips them in the bud, in the long run.

Now some of the most powerful ones have recognized that you just can't fight gold forever. It drains too many resources.

So they figured: "Hey, if there is such a demand for fiat by the public for transactional purposes, and if fighting gold drains too many resources and creates too many imbalances in the world of finance, then let's have it both ways! We can give the masses their fiat and control them that way, while we save gold. Let's totally disconnect gold from any official currency use by letting it trade freely at whatever fiat-value the market brings, and protect our purchasing power with gold, not fiat or fiat derivatives."

Sharing the Power

They see of course that in doing this they will open the door to empowering the masses to do the same, but alas, such is the price of leadership. You can just hear them: "Sometimes you just gotta give the 'plebs' what they want - even if it's a piece of our own power. Better have a little bit less power and preserve it long term than have all the power short term only and have it all come down crashing on our heads someday."

They see, of course, that the current dollar system is untenable. They have seen it for the longest time, even way back from 1971. So they quietly, unassumingly, through painstaking work, created the conditions that would make a brand-new super-currency possible, one that could compete with the dollar in terms of the size of the underlying market it services, and in terms of international desirability as a trade medium and currency reserve.

I'm talking about the euro, of course.

That this is exactly the plan can be seen by the steadfastness with which the ECB pursues its stability-oriented interest rate policy. Despite all the pressure coming from the euro member countries to drop rates so they can goose their stagnant socialist economies like the Fed does here, the ECB has held fast so far - and continues to do so. Even though the Maastricht Treaty's 'growth and stability pact' has suffered tremendously by the council of ministers' refusal to hold France and Germany accountable for their budget excesses, the ECB has stayed its course. And now, even though oil is threatening to fire up price inflation and further strangle those members' economies, the ECB has announced it is not changing its policy.

That's quite a feat for a central bank - and is a clear sign that the ECB is marching to a different beat than the US Fed, altogether. The plan is to convince the world that the euro is at least as good, if not better, than the dollar as an international trade medium and as a currency reserve.

The plan is NOT, however, to convince the world that the euro is as good as or better than gold.

Rather, the plan is to free gold from all governmental price controls and let it literally run free.

The euro has nothing to lose by letting gold rise. One clear sign that this is so lies in the fact that the euro system values its collective gold reserves at market price - whatever that may be. This shows more than just their concept that an ounce of gold is worth more to them than $41.22. It shows a definite philosophical, psychological, and especially political break from the American notion that, in order for their fiat currency to prosper, gold must be 'controlled.'

It shows a willingness to let gold rise to whatever price it may, because the euro is not competing with gold in its function as a savings-medium, as the dollar is. The euro is not even competing with gold as a currency. History since 1971 has already proven beyond a doubt that there is virtually endless demand for fiat.

No More Conflict

There is simply no conflict - as long as each is allowed to operate in its best-use arena.

Even though it may be the case that gold is used as a currency again, especially when efforts like those of Hugo Salinas-Price with Mexican silver coins take hold and bear fruit, this still would not threaten the euro and its eventual copycats. It just happens to be the case that fiat is better suited for day-to-day transactions while gold is better suited for saving. Any such gold/silver coinage (including online digital gold currencies) would of course become as tradeable as fiat, but because people will recognize that gold is the better 'value-safe,' it will rather be hoarded than spent.

This will only change once gold and fiat have reached their natural "equilibrium price" - whatever that may be. Maybe it's thousands and thousands of today's dollars, or euros, or whatever. Maybe its only a few hundred (highly unlikely, but theoretically possible). Once that level is reached, gold/silver may circulate as much as fiat will - but there will still remain that one important distinction: you can't "print" precious metals!

So, even then, gold will always remain the favorite value-safe - and that's why the entire notion of fiat having to 'compete' with gold in that arena is really misplaced. It was a giant international monetary policy snafu. Gold has its perfect sphere and primary function - and fiat has its.

Either one may make temporary inroads into the other's 'territory.' Some fiat will undoubtedly be saved, at least short-term. Some gold will undoubtedly circulate along with fiat - but so what! Who cares? The fiat powers will be assured of a more stable, self-supporting world financial system once such an equilibrium has been reached (a system they can still manipulate to their hearts' content) because gold-suppression efforts no longer drains their resources. The gold hogs (the rich, and the not-so-rich gold savers in the world) will be assured of the value of their accumulated wealth.

And all will live happily ever after...

... except those who don't have any gold and must buy it, if they want it, at ever higher prices in the future.

Some day in the not-so-distant future, even avid gold traders who trade for gold's paper-value in paper-form for future hoped-for paper-riches will recognize that the real "killings" will be made by owning and holding physical - for the long haul.

Some day in the not-so-distant future, even hedge funds and tech funds will figure out that holding physical is way better for their bottom line than trading its paper-derivatives for depreciating fiat profits.

Because of the sheer volume these outfits are able to move, that will be the day when the real gold price-hike begins. Unfortunately, a lot of water will run down all the rivers before that day comes. It is not a two or three-month proposition. Gold will "crash" and almost instantly recover many times before then, but those who can hold their gold until then will live like Kings - or better.

But first, there must be a divorce. A real divorce, not a legal "hostage crisis."

Got physical?

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is your golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Copyright © 2003-2008 Alex Wallenwein

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