Friday, December 24, 2010

SHORT HISTORY OF PAPER MONEY (greenbackers beware!)

The Descent of Money
by Bill Bonner

Science and technology have produced many wondrous breakthroughs. But
there are some things it cannot improve. A kiss from natural lips is
still the lover's choice. Baby formula proved no match for the real
thing. Ersatz money is a flop too. That last item is not so much a fact
as a prediction.

The first modern competition between gold and paper money ended like
the pre-modern ones. Gold won. Herewith, a short summary:

John Law's Franc

A rogue, John Law, was the protagonist of the story. He killed Beau
Wilson in a duel. Then, he went on the lam...first to Scotland...then
to Amsterdam...and finally to Paris. Like Alan Greenspan or Ben
Bernanke, he made himself useful to people in high places - in this
case the Duke d'Orleans, who needed money. Law had a way to get it:

"I have discovered the secret of the philosophers' stone," he is said
to have remarked, "it is to make gold out of paper."

We need to look no further. Law may have been good with figures; it was
at philosophy that he failed. A thing cannot be both one thing and a
different thing at the same time. It is either gold. Or it is paper.
Rarity and durability give gold value - as money. Paper's most
conspicuous properties are just the opposite - it is common...and has a
tendency to curl up and blow away.

Law's new, easy money helped France to an economic recovery - or so it
seemed. But in the end, the philosophical error caught up with him.
Gold has real value. If you can create it at will, why not create more
of it? It was just a matter of time before he had created too much.
Soon, there was an angry mob outside Law's office on the Rue
Quincampoix. People who held his paper gold had come to see it in a
different light. Where once they cherished it as paper they
despised it as nothing but paper.

Law's scheme increased France's money supply - including banknotes and
shares in his Mississippi company - by 300%. Prices in Paris doubled
between 1718 and 1720. Then, when the new money system began to give
way, the Duke d'Orleans "cranked up the printing press." By 1721, Law's
money was worthless. "Banque" was a dirty word in France for the next
200 years.

The current experiment with paper money began on the 15th of August
1971. Henceforth, said Richard Nixon, foreign countries that wished to
exercise their right to trade US dollars for gold could drop dead. From
that point forward, the dollar was worth only what someone would give
you for it. Philosophers held their breath. But nothing happened. Many
have died since, waiting for the dollar to succumb first. Still, the
millstones of monetary history may grind slowly, but the more slowly
they grind, the more fingers they pinch.

The new paper money standard allowed for a worldwide credit boom - just
as in Paris following the establishment of Law's scheme. The US created
dollars. Its citizens spent them. The dollars accumulated as reserves
all over the world...and every central bank raced to keep up. Soon, the
exporters were producing too much. The importers were consuming too
much. And there was too much money and credit everywhere.

The Japanese economy was the first to blow up - in 1989. The tech
sector on Wall Street was next to go - in 1999. Finally, in 2007, the
planet-wide bubble popped. Suddenly, the whole world was Japan. And
now, every nation in Christendom, to say nothing of the others, is
following Law's example. All issue paper gold - in the form of bills,
notes, and bonds - as if they were the Banque Royale. Europe is
estimated to need $2.2 trillion in deficit funding this year. America
will need at least a trillion more. If the depression deepens, maybe $2
trillion. How long can this go on? Where will it lead?

"There are no means of avoiding the final collapse of a boom brought
about by credit expansion," wrote Ludwig von Mises. "The alternative is
only whether the crisis should come sooner as a result of voluntary
abandonment of further credit expansion, or later as a final and total
catastrophe of the currency system involved."

On Tuesday, the S&P rating agency issued a warning. If Japan continues
in the direction it is going, it will have Hell to pay. Japan leads the
way into the future. And into a monetary minefield. Her current deficit
- a record - is more than her tax revenue. And her public debt is
nearly 7 times as great. Her feet grow larger.

No natural life survives the lifecycle. And no paper currency standard
has ever survived a complete credit cycle. It is just a matter of time
until we hear the explosion and see body parts flying.

Bill Bonner,
for The Daily Reckoning


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