Editor's note: Originally published on July 2, 2014
Written by Peter B. Meyer
Some regular readers requested for more information on the effects of hyperinflation. For complete insight, first a few essays on inflation and deflation and its consequences.
The modern rivalry between gold and paper money will end like all others before. Gold always won.
A villain named John Law (1671-1729) is the protagonist of this modern history. He killed a guy called Beau Wilson in a duel. Then he went on the first flight to Scotland, from there to Amsterdam, and finally to Paris. Like Alan Greenspan and now Ben Bernanke, to learn a way to make money he made himself useful to people in high places - in this case the Duke of Orleans, who desperately needed money:
"I have the secret of the philosophical stone discovered," he said, "it is the way to gold paper." We no longer need to search for gold. John Law was perhaps good with numbers, but not so with his philosophy, because that failed. One thing cannot be at the same time two things. It's either gold or it is paper. Rarity and durability give gold value as money. Paper has the distinctive feature just to be the opposite - it is not scarce, and it wrinkles so it can blow away.
John Law's new invention increased the amount of money that France helped to create an economic recovery - at least so it seemed. But ultimately, his philosophical mistake became visible, because gold has real value. If you can create money whenever you wish, why not print more of it? It was just a matter of time before it became clear that too much of it was printed. Soon there was an angry mob at the door of his office in Paris on Rue Quincampoix. People who had acquired his paper gold began to see its value in a different light. Once cherished as paper gold, appeared to be nothing other than plain paper.
Law's idea enlarged the money supply; it increased by 300% in France. Prices in Paris doubled between 1718 and 1720. When, his new money system collapsed, the Duke of Orleans started "to print even more of it." In the year 1721, Law's money was worthless. So the word "Bank" for the next 200 years was a dirty word in France.
The current experiment with paper money began on August 15, 1971. "From now on," said U.S. President Richard Nixon, all foreigners who want to do business with us lose the right to exchange their dollars for gold. From that moment, the value of the U.S. dollar was determined by what someone gave for it. Philosophers then held their breath. But nothing happened. Many died meanwhile, because waiting for the dollar's collapse took too long. The millstones of monetary history may be slow, but the longer it lasts the more fingers are trapped.
The resulting paper money standard caused a global credit expansion - just as then in Paris after John Law's application. Again, the U.S. Federal Reserve prints U.S. dollars, which the citizens spend.
These dollars as reserve currency are building up around the world, and each central bank is doing its best to keep up with the same printing process. Soon, exporters over-produced because importers consumed too much. And so it happened that the world is awash of too much money (credit expansion) that came into circulation.
The first victim of this was the Japanese economy in 1989. The next victim was the crash of the Dot.com High-Tech sector on Wall Street in 1999. Finally, in 2007, the entire (financial) planet became a big bubble, which imploded. Suddenly, the whole world was in the same economic situation as Japan nearly 20 years earlier. And now, every nation follows the example of John Law, by issuing paper gold in the form of banknotes, through providing promises on loans and bonds - as if it were the Banque Royale from then. It is estimated that Europe, for its necessary financing, does have a short fall of € 3 trillion. America may need at least 4 to 5 trillion more. How long can this go on? Where will this lead?
"There are no means to prevent an eventual collapse, caused by excessive credit expansion," wrote Ludwig von Mises (1881-1973). "The alternative is only whether the crisis comes earlier rather than later as a result of voluntary abandonment of further credit expansion, or as the final and total catastrophe of the collapse of the currency system is fact."
If Japan continues on the road where it goes, the country will go bankrupt states S&P. Japan leads the way to the future, a monetary minefield. Their current deficit - a record - is more than its tax revenues with a public debt seven times larger. Caused by living beyond their means.
"No natural life survives this live cycle. And no paper currency has ever survived a full credit cycle. " It's only a matter of time until we see the explosion.
This article is written by Peter B. Meyer, financial editor of Doijer & Kalff. This article appeared on TEKjournalismUK in February 2012.