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Gold and paper currencies have been at war for more than three thousand years. When currencies were pegged to gold, they appeared to coexist peacefully. Nevertheless, when the peg ceased internationally, they became each other’s nemesis and thus began the battle for monetary supremacy. A study on the history of money, and its relationship with inflation, is essential to appreciate the role of gold as money.
For paper currency, there is always a boom-bust cycle. It often begins with the healing of a country’s economic woes and promises of prosperity for all. To better illustrate how the boom-bust cycle works, one can draw reference to the recent economic history of United States. In the late nineties, US technology stocks formed a huge bubble mainly because of over leveraging of debt through low interest rates. Start-up technology companies with mediocre or even negative earnings were valued in the millions. After the crash, which coincided with the terrorist attack on New York, interest rates were lowered again to spur economic growth, forming another bubble in housing. When the housing bubble burst, it almost took down the whole world's banking system with credit facilities drying up, thus triggering the global financial crisis in 2008. With interest rates kept near zero, special measures in the form of money printing were needed to boost the economy and create jobs.
These cycles have been repeating for centuries. According to Nick Barisheff’s $10,000 Gold, it seems that countries that broke peg with gold standard and introduced fiat currencies go through a five-stage cycle.
Stage 1 is fuelled by optimism and euphoria as politicians promise growth stimulus with the least amount of pain and discipline. In the beginning, there will be promise of fiscal responsibility to print only what the country needs and live within the budget means. However, such period is usually short-lived as politicians and central bankers will soon give in to temptation to print more money so as to stimulate growth.
In Stage 2, restrictions would be slowly removed from the currency-creation process. The idea of paying off debt is no longer important as compared to growth. As a result, growth becomes the single most important driver of the fiat system. As currencies gradually lose value, due to declining purchasing power, people have to work longer hours to maintain their standard of living.
Stage 3 is the gambling stage where excessive liquidity makes its way into the stock market and real estate market. Growth will start to slow down and therefore, more money needs to be created to stimulate growth. This means that interest rates must be maintained at artificially low levels. With interest rates kept low at the same time there's significant money printing, people will have to take risks on the stock market or real estate market just to keep up with inflation. In stage 3, people also start to borrow more because of the wealth effect with the bubbles causing them to feel like they have more money than they do in terms of purchasing power.
Stage 4 is the penultimate stage of the fiat cycle. Sluggish growth in western countries force financial institutes to try make money through other means than financing and brokerage fees. At this stage, corruption prevails, fundamentals are ignored and wealth is concentrated in the hands of a few. At this point, individuals must look out for themselves by not trusting the government or financial advisors. Those who failed to do so would suffer potential loss of wealth in the latter part of Stage 4 and Stage 5.
Stage 5 occurs when there is hyperinflation, which is the worst economic phase of the fiat cycle. In stage 5, the currency becomes worthless. At this stage precious metals are often reoccurring in the monetary system to be used as currency or be used to back up the currency. Keep in mind that hyperinflation has occurred at least 56 times during the last two centuries.
At each cycle, only the “movers and shakers” can influence lawmakers to implement laws that benefit the rich and elites, especially those with the highest concentration of wealth. The middle and low income groups lose out the most and tend to feel that “the rich get richer”. This is due to the rapid erosion of purchasing power caused by the inflation. During each stage of inflation, gold appears to rise in value as currencies continue to lose value. This is because as paper money loses value, the only alternative will be real money, represented by precious metals such as gold and silver. The increased demand means that they will appreciate in value not only against fiat currency, but also against other tangible assets.
There is strong possibility that the global monetary system may collapse in the near future due to a crisis of confidence in the paper money system. Individuals must realise that the current debt-based model for the monetary system is not sustainable and there will come a breaking point when the government debts become uncontrollable. When that happens, you want to keep your assets in the only real money - Gold and Silver!