We are witnessing the 'collapse of money itself' - says gold bug
by Justin Stares
Forget about Europe's financial woes - they are only a sideshow, a distraction from the real story. Rather than the collapse of the single currency, what we are really witnessing is the collapse of money itself. So says Detlev Schlichter, the former bond trader who abandoned his career to explain to the world the true root causes of the financial turbulence of the last five years. His book Paper Money Collapse - the Folly of Elastic Money the Coming Monetary Breakdown claims the crisis pre-dates the shocks of 2008 or the creation of the euro a decade ago. The real root cause, the 47-year-old says, can be traced back to at least 1971 and the decision to cut all remaining links between the United States dollar and gold.
By abandoning the gold standard, the US, and consequently the rest of the world, switched over to "fiat" currencies based solely on the trust of the people holding the notes and coins. Central banks were given the power to print money ad infinitum and with impunity - leading to inevitable and constant injections into the system. Over time, world markets have become unhinged and addicted to ever-larger fixes of cheap cash.
"All fiat money systems have ended in failure," says Schlichter, who while born in Germany has since 1996 lived in London with his wife and three children. The eurozone is club of "bankrupt and semi-bankrupt states"; the idea that the semi-bankrupt can bail out the bankrupt is "ludicrous" – he says. We are "practically in a Weimar Republic type of situation" in which banks and governments "can't cope" with the required contraction in credit because they would simply go bust. The endgame, Schlichter predicts, will be a desperate attempt to inflate away debts - a policy that will only work until the public realises it is being ripped off and loses all faith in paper currencies of whatever denomination. After which, he is sorry to say, will come "complete disaster".
It's an apocalyptic scenario but one Schlichter explains on his blog Paper Money Collapse, with clarity and modesty. The blog's target audience, like that of the book, is fairly high-brow. You have to be comfortable with phrases such as "capital misallocations" or "manipulation of credit markets" to enjoy the contents. What drives a man to pack in trading, rent a small office in St John's Wood, and write about an impending Armageddon? Schlichter tells PublicServiceEurope.com that it became impossible for him to reconcile his job with his love of "Austrian school" economics, a laissez-faire philosophy that puts human behaviour at the heart of all theory.
"For quite some time, I had felt an acute tension between my 'Austrian' insights and libertarian convictions on the one hand and my day-job as part of an increasingly unstable global fiat-money system on the other," says Schlichter, who trained with J.P. Morgan before going on to work for US bond specialist Western Asset Management - where he headed a team that oversaw investments worth $60 bn. This tension grew when the US Federal Reserve switched from "tightening" to "easing" in response to the Russian default and the bankruptcy of the Long Term Capital Management hedge fund in 1998. Schlichter recalls: "The Austrian School theories explained why this might lead to a near-term recovery or even a continuation of the preceding boom - and it did indeed - but only at the price of having the financial system accumulate more imbalances. Bankers and traders now knew that they could rely on the central bankers as lenders of last resort. This encouraged more risk-taking. Leverage everywhere increased rather than decreased as would have happened if the crisis had been allowed to run its course."
Things began to look ominous in 2001 when the Federal Reserve lowered interest rates to 1 per cent and kept them there, creating the housing bubble that led to the subprime bust. "At this point, I began to see that this was not just a policy mistake but a pattern that was an integral part of the system and that was the result of erroneous theories about how 'easy' money works," says Schlichter. "These problems were systemic and at their core was intellectual error. The mainstream today believes in 'elastic money' as a great policy tool to make the economy more stable. The opposite is true. Elastic money makes the system unstable. Previous generations of economists had understood this better."
The 2008 crisis was Schlichter's tipping point. "The policy response became even more extreme. Monetary accommodation on an unprecedented scale globally. At this point, I realised that I had to get out." He was, he says "surprised that the fundamental problems with our monetary system were now not clearly visible to everybody". Did people not see that this path must have a nasty endgame? "I decided to leave the industry, think these things through properly, and write a book about it," he explains.
Visit the blog and you will see that Schlichter has become something of a hero among gold bugs. He believes in the inherent value of the yellow metal and advocates a return to the gold standard, while accepting this is unthinkable for today's politicians. His ideology - based on the teachings of Austrian school hero Ludwig von Mises - is very much in a minority. Almost all mainstream pundits currently focus on government intervention in the marketplace, rather than government disengagement. Some of Schlichter's views - he believes in zero taxation - could perhaps justifiably be described as extreme.
But given the extraordinary times we are living in, and given the manifold mistakes made by policy-makers in recent years, who has the right to pass judgment on a contrarian? At last month's Brussels Economic Forum, a European Commission event, panellists sniggered with condescension when a member of the audience suggested a return to the gold standard. On Bloomberg Television, proponents of gold-based money are given similar short shrift by pundits and presenters alike. But who among them predicted the crash of 2008? On a lighter note, Schlichter might not believe in the value of paper money, but his publishers certainty do. His book costs £19 in the UK and more than $26 in the US. While the financial system holds out, all credit cards are accepted. You have to smile.
A potent wealth preserver, gold's stability remains as compelling as ever for today's investor operating in such a fragile economic environment - writes Marcus Grubb
With all due respect, and I have zero training in economics, there is no reason I can see why gold is a very good standard. It is about as free of inherent value as a paper dollar, that is the price is not determined by any physical need but only by a superstitious notion that it is relatively risk-free. Didn't George Soros decide to get out of gold completely not long ago and put more effort into investments in agricultural land? I have a vision of the end of he world marked by two multi-trillionaires sitting next to their mountains of gold in an endless desert, engaged in a fight to the death over a can of rotten beans - which unlike gold, will retain real value until no one is left to eat them.
With this vision, I'd suggest that a far better standard than gold - if a physical standard should be adopted at all - would be the price of rice averaged over a several-year period so as to take into account weather changes that affect its availability. That is because, unlike gold, it has a not-very-changeable relationship to the actual relatively unchanging needs of actual people and has a much more stable market on that basis than gold ever could have; thereby assuring that the value of money on a rice standard would not very enormously even over millenia.
Currency, like a constitution, is just paper. And its value is based upon trust. Fundamentally, trust is what is at this time collapsing. For primarily environmental reasons, no one can any longer trust anyone else to provide them with basic security - a warm place to sleep, with health care and food. If we were ever to fix that, our financial difficulties would be fixed at the same time.
Nicholas C. Arguimbau - Warwick, MA, US
Mises taught that all money must have its origin in something that inherently was deemed to have value. Paper may have been considered a claim on such value but if the paper claim could not be redeemed, it was then immediately worthless.
Consider a grain storage facility that gives warehouse receipts to farmers for their grain. Imagine the farmers started using the receipts as money because the holder could redeem it for grain.
Now imagine that the ability to obtain grain was suddenly removed - perhaps the storage facility started printing their own receipts that were not backed by grain and started using it as money. Sooner or later, the warehouse receipts' perceived value would drop to zero - as people realised they were meaningless pieces of paper that were not a claim on anything.
That's what we have now, with gold and currency. Gold is money - everything paper is a claim on money.
Dale Holmgren - Millbrae, CA
