BOOM Goes the Dynamite!

It's been a while, and you probably don't remember it very well (at all), but remember this post? It was a quote from Marco Polo, who discovered the use of fiat money in China.

For those who don't know, let me explain quickly (whatever) what fiat money is. In a nutshell, it's money backed by nothing but the "good" promises of the government. Way back when, people used to trade in gold and other precious metals or valued commodities. Gold happens to be heavy and hard to lug around in large quantities, so people with gold started asking goldsmiths to hang on to their gold for them because the goldsmiths had good vaults for that kind of thing. The goldsmiths wrote out a receipt for the amount they were holding, and the owner of the gold could then go about town knowing his money was safe. When he wanted gold, he could come back and show his receipt and get some of his gold, whereupon the goldsmith would issue a new receipt that reflected the lower amount the owner now held.

This went on for some time, and with good, solid gold backing every transaction, prices stayed very level for years on end. After all, gold is difficult and expensive to mine, so the small addition of new gold into the marketplace every year didn't cause a lot of inflation.

It didn't take too long for gold owners to realize that they didn't even need to go back and collect physical gold in order to buy something. They could use a note from the goldsmith instead, and if the goldsmith was credible and trustworthy, a note from the goldsmith was as good as...well, gold. When the gold owner signed over one of his notes, the new note owner could go to the goldsmith and take possession of the physical gold if he wished. Or, he could pass along the note to another person, who then had the choice to collect the physical gold or use the note as legal tender.

Up until 1971, this is what trade looked like in the United States. The dollar bill you had in your hand could be traded in for a dollar's worth of physical gold or silver, should you so choose.

Ah, but there was a twist. Let's go back a little bit to the goldsmiths with the vaults.

With all that gold in their vaults and knowing that the owners, who now had handy and lightweight pieces of paper to use as legal tender instead of lugging around a sack full of gold coins, the goldsmiths realized the the chance of all the gold owners coming in to collect their physical gold at one time was pretty close to zero. This meant that they could make some money on the side by lending gold to someone else, charging the guy some interest, and then getting the gold safely back into the vault, with the interest disappearing into the goldsmith's pocket. Gold owner Bob knew his gold was available whenever he needed it, but goldsmith Jim could lend some of Bob's gold to Sam for a certain amount of time, and Sam had to repay the loan with a bit extra by the time his loan was up. Jim pocketed the extra interest, and Bob's gold was all back together again.

That was the birth of fractional reserve banking. The goldsmith had a reserve of gold (brought in by the original owners and stored in his vault), but he loaned out portions of it to others who did not necessarily have gold in his vault. The gold was therefore fractioned (kind of like being in two places at once: both in the vault and in Sam's hands), and the goldsmith was banking (ha ha) on the fact that Bob and all the other gold owners wouldn't come walking in at the same time and demand all their physical gold, which Jim no longer had. Sam had some of it, Andy had some of it, and so on (watch that scene in It's a Wonderful Life where Jimmy Stewart explains this to the panicked banking customers).

Fractional reserve banking is what makes banks their money, and sometimes banks got greedy, fractioning their reserve to dangerous levels. When account owners wanted their gold, the bank had fractioned it so far that they didn't have the physical gold on hand to give to the account owners, and the bank went belly-up. The lucky ones were the account owners who got there first and got their gold. The unlucky ones didn't get anything.

Banks and credit unions all do business this way, with the profit either going to line the bank owners' pockets or getting divided amongst the account holders. The smart ones don't fraction their reserve past a certain level, of course.

In 1971, President Nixon decided to ditch the gold standard. Suddenly, the American dollar was free-floating with nothing to back it except the collective belief that these pieces of rag paper and ink were worth something. And because the dollar was the world reserve currency (meaning the entire world trades in American dollars for oil and other imports), the Federal Reserve could print more money whenever it felt a need. (Don't get me started on the constitutionality of the Federal Reserve. Let's just say that it is the fox in the hen house and leave it at that.) This dollar, which is now backed by nothing except a promise, is called fiat money, fiat coming from the Latin "let it be done," meaning that it is printed and made valuable by government decree. Now is a good time to re-read Marco Polo's description of ancient China's pretty painted notes.

What is significant is that every single economy that has succumbed to the sweet and easy temptation of fiat money has collapsed. Every. Single. One. Why? Because, like children wanting a sweet and not wanting to wait until after dinner, it's simply too easy to pay debts and take care of business by printing more money. With no need to worry about the amount of physical gold in the treasury's reserve in case all the creditors decided to cash in their dollars for gold, paper money just keeps sliding off the printing press. What happens when you flood the market with something? The value of all of that thing rapidly gets reduced. I am reminded of the Spongebob cartoon wherein Mr. Krabs sold Spongebob a ridiculous novelty hat for an exorbitant price. Mr. Krabs congratulated himself on pulling the wool over Spongebob's eyes until he found out that those novelty hats were worth $1 million. By the time he got it back and went to claim his million dollars, truck loads of the caps had been found and his hat was worth nothing.

Using silly cartoons to make a point is my prerogative. Don't be hating.

Flooding the market with dollars means that each of those dollars has less and less buying power. Add to the risk of massive inflation (the dollar has lost 95% of its value since the Federal Reserve took over the tender, loving care of the American economy) the fact that some of the big movers in the world (China, Russia, France, Japan) are now talking about ditching the dollar as the world's reserve currency and you can see why I'm stressing about my food storage. Think gas is expensive now? Just wait. And it's not just prices of commodities. It's the way of life that we are used to. Seriously, people, I don't think it's too much to say that things will go BOOM in a big, big hurry. Remember Germany after WWII? Yugoslavia in the early '90s? This will probably be worse.

Thank you for indulging me. I had to get that off my chest.