1971: the beginning of the end?

A fiat currency is a money system that is not backed by a physical asset such as gold or silver but instead by the good will of the country and its economy. Presently the entire global economy is on a fiat currency, which is the first time this has occurred in the history of monetary policy. This new regime came into existence in 1971 when then US President Richard Nixon convinced the world to move off the international gold standard. This was a significant event in monetary history and once this step was taken we moved into a new frontier.

What is interesting is that this has been tried before by nations and the outcomes have always been the same, yet this time it is believed that the outcome will be different. Only time will tell.

In more modern times we have seen the fiat currency been trialed and one notable example is Germany in 1919 when the country went off the gold standard and started printing money to help expand their economy. Before this rapid expansion of currency took place 12 marks equaled 1 US dollar. At that time the US dollar was backed by gold and was on the gold standard, however Germany continued to increase their money supply over the coming years and by the end of 1923, 4.2 trillion marks equaled 1 US dollar. Due to the rapid expansion of monetary supply into the system the purchasing power of the local residents of Germany was decimated.

More recently Zimbabwe in 2006 also attempted the same economic stimulus policy by expanding their monetary supply. The outcome was unfortunately similar to German’s experience in that about 4 US dollars was worth around 10 million Zimbabwe dollars and by 2009 100 trillion was worth around $30 US dollars.

The US has attempted a fiat currency a number of times throughout history and in 1775 created the “continental” where $1 dollar of gold backed currency was worth $26 continentals. However by 1981 it took $168 continental dollars to get $1 backed by gold as a result of this erosion of purchasing power in the US.

As history has shown, the demise of the fiat currency in each case was caused by the ramped amount of dollars into circulation to fund the country’s short-term economic objectives. This is because increase in the amount dollars in circulation devalues the purchasing power of the citizens and inflates the cost of the goods and services. While to some degree in the short term there is an illusion of becoming wealthy as asset prices increase steadily in value, in actual fact the printing press only accelerates inflation and becomes difficult to control. Consequently, this has resulted in the decimation of the citizen’s purchasing power and history has shown that countries end up reverting their currency back to the gold standard.

A lot of people would be surprised to know that Australia too has been printing huge quantities of money to ensure it keeps pace with the global printing press. In fact our currency supply has increased by more than 300% since 2000. This rapid increase in monetary supply has inflated all goods, services and hard assets thus providing us Aussies with a feeling of becoming wealthy, when in reality our purchasing power is being rapidly eroded.

So when we look back throughout history and see so many times when the fiat currency has failed and then review the current situation with the US dollar – since 1920 it has lost 94% of its original purchasing power – you only have to wonder if this fiat currency’s future will end with the same fate as its predecessors.

In reality the only true way to protect your wealth from the description of rapid monetary creation and the depreciation of purchasing power is to purchase gold and silver bullion. Since the creation of money this has stood
the test of time. Furthermore both gold and silver have produced an annualised return of 15% since 2000 making it the strongest performing asset classes since the start of the decade.