In 1593, a botanist named Carolus Clusius introduced the tulip plant to Holland, after bringing it back from a trip to (what is now) Turkey. The Dutch people first became enamored, and then obsessed with tulips – and the value of tulips soared in that society to absurd levels.
An article on this episode in history provided examples of how high the value of a tulip had risen. A rare “Viceroy” bulb could sell for the equivalent of $1200 USD today, while in a more-detailed, barter transaction, a bulb was traded for a bed, a complete suit of clothes, and a thousand pounds of cheese. While a very amusing anecdote; from an historical perspective, “Tulipmania” (as it was dubbed) is seen as an example of the first “asset bubble”.
The value of tulips in Holland soared for over 40 years. Then, in 1637, a single publicized transaction failed to take place, when the buyer didn't show up to conclude the deal. Like they had suddenly removed a veil from their eyes, a “panic” ensued among the Dutch – as tulip-holders suddenly all wanted to exchange their tulips for assets with real value. Within a matter of days, the value of a tulip had shrunk to only 1% of its previous worth. Today, we can't help but ask the question: “what kind of fools could have believed that a tulip was an item of value?”
While this episode is illustrative with respect to asset-bubbles, it is an equally useful example of the life (and death) of a form of money. What is important to note about “Tulipmania” is that soon after this fad started, tulips were deemed to be “too valuable” to simply be stuck in the ground and allowed to bloom – because someone could steal them. Thus, “trade” in tulips was quickly replaced by simply trading tulip bulbs. In other words, the tulip bulbs became currency.
For those unaware of what a tulip-bulb looks like, the same article to which I referred earlier also mentioned an anecdote of a visiting sailor who mistook a tulip-bulb for an onion – and ate it. Thus, what was being used as money was something with absolutely no intrinsic value. Once the bulbs ceased to be used to produce flowers (because they were “too valuable”), they didn't even have any aesthetic appeal.
There was a second reason why this “currency” was doomed to fail, in spectacular fashion. Once the Dutch people acquired the knack for growing tulips, they could essentially be produced in infinite quantities. The Dutch people were about to learn an important lesson about money: in order for any form of money to hold its value over the long term, it must be “precious” or rare.
Again referring to tulips, when they first became money, they were both rare and precious. They were originally few in number and since they were originally traded as flowers they were also beautiful (or “precious”). However, when the Dutch began to produce tulips in vast quantities and they also ceased to be “precious” (because they were now traded as bulbs), tulips lost the essential qualities of “good money” - and quickly became worthless.
Regular readers will recall that I have previously provided the criteria for “good money” in previous commentaries. There are four necessary qualities which all money must possess, or else thousands of years of history teaches us that such “money” is doomed to fail as a currency.
In addition to being “precious” or rare, good money must also be uniform, evenly divisible, and “a store of value”. The properties of being “uniform” and “evenly divisible” are basically self-explanatory, but I will spend a moment to illustrate the importance of money as a “store of value”. This refers to the requirement that “good money” must retain the wealth of the holder. For example, over a span of centuries, an ounce of gold has been sufficient to buy a fine, man's suit. Conversely, the foolish Dutchman who traded his bed, a suit of clothes, and a thousand pounds of cheese for a tulip bulb, suddenly woke up one morning and realized that all he was holding as a replacement for that wealth was one, common flower.
When discussing money as a “store of value”, we cannot fail to discuss how the U.S. dollar – the world's “reserve currency” - has performed as a store of value. In the less than 100 years since the Federal Reserve was created to “protect” the dollar, it has lost more than 95% of its value. Put simply, the dollar of today is not “a store of value”, and thus not good money.
The question then becomes: was the dollar ever “good money”, and (if so) what has changed over the last 100 years?
In the chart below, you can see “inflation” in the U.S. (as measured by the “consumer price index). In fact, what “inflation” really tells us is not “how fast prices are rising” but rather, how fast our currency is losing its value. A pound of beef doesn't become more delicious or nutritious over time, the reason why we must pay much more for a pound of beef than even a few years ago is that our “money” is rapidly losing its value. With the U.S. dollar officially created in 1785, the chart presents the complete history of the U.S. dollar as a store of value.
Thus what this chart tells us is that for nearly two hundred years, the U.S. dollar was a good “store of value”, and then suddenly (around 1970) that changed – and more than 80% of the dollar's loss of value has occurred in the last 40 years. As any reasonably knowledgeable precious metals investor knows, it was in 1970 that the United States went off of the “gold standard”.
In other words, what we see is that the U.S. had 200 years of price-stability (i.e. the dollar retained almost all of its value) while on the gold standard, followed by an 80% loss of value in the 40 years since. Quite simply, it was never the U.S. dollar which was a good store of value, but the gold that was “backing” it. As soon as we removed such backing, the U.S. dollar ceased to be “a store of value”. In other words, it was no longer “money”, but is now merely currency.
To put it another way, the U.S. dollar has gone from being (literally) “as good as gold” (when it could be converted into such) to just another “tulip”. Like the tulip bulb, it has no intrinsic or aesthetic value of any kind and it can be produced in infinite quantities. It is important to note that a gold standard functioned in two ways in preserving the value of the dollar. First of all, when “backed” by gold, gold was able to transfer its status as a store of value to the dollar. Of equal importance, when a currency is backed by gold, this provides a fixed and finite limit on how many new “dollars” could be created – and along with that, how much debt.
Thus, a gold standard served to not only imbue our currencies with intrinsic value, but also forced governments into being fiscally responsible. As Europe goes through a continent-wide “debt-crisis”, and with the United States far more insolvent than even that poor, scapegoat Greece, I am sure that there are vast numbers of readers who wished (in hindsight) that these “leaders” had been constrained by the enforced discipline of the gold standard.
However, I know (from experience) that there are also vast numbers of readers who refuse to abandon their delusion that the U.S. dollar is better “money” than a tulip bulb. Equally, there are undoubtedly other readers who don't understand (or refuse to accept) how and why gold is inherently more valuable than a U.S. dollar. Fortunately, I can deal with both of these positions in the same discussion.
First of all, with no gold backing it, the only “value” that can be derived from a U.S. dollar (or any paper currency) is the underlying net asset value of the economy which issues that currency. In other words, stripped of precious metals “backing”, the value of a U.S. dollar is derived in an identical manner to the value of a shares of a corporation.
You cannot take your “share” of Microsoft and say “give me a piece of Windows”. Similarly, a dollar-holder cannot walk up to the U.S. government with a truck-load of dollars and ask to “redeem” those dollars in nuclear missiles, or some other “hard asset”. Instead, like the shares of a corporation, a U.S. dollar (or any other un-backed currency) derives its value from the collective worth of the issuing entity, prorated into those individual currency-units (or shares).
In the case of the United States, we have a country with total public/private debt amounting to roughly $60 trillion and “unfunded liabilities” in excess of $70 trillion. Put another way, both the debts of the U.S. and the liabilities of the U.S. equal or exceed global GDP, meaning it would take two Planet Earths - devoting all their resources – just to service those debt/liabilities, as each number implies a debt-to-GDP ratio of 100% (or more). My own calculation puts the net worth of the United States at -$80 trillion - although I would be perhaps willing to give a little ground on that calculation.
Clearly, the United States is hopelessly insolvent (i.e. its “net asset value” is far below zero), meaning that the U.S. dollar is already totally worthless. Even the Dutch tulips were worth more – as they had no creditor-claims attached to each and every tulip. Thus today we can't help but ask the question: “what kind of fools could believe that a U.S. dollar is an item of value?”
Let me take a moment to address the "relative value" argument, put forth by the U.S. propaganda-machine on a daily basis, to supposedly "explain" why the U.S. dollar has rapidly appreciated versus the Euro in recent days/weeks. By its very definition, no "currency" could ever, possibly be worth less than zero. Thus it is impossible to argue that the worthless U.S. dollar could be worth more than the Euro. Indeed, the entire appreciation of the U.S. dollar versus the Euro this year can be attributed to four solid months of around-the-clock fear-mongering by the U.S. propaganda machine. You don't even have to have a suspicious mind to believe that one of the prime motivations for this propaganda-campaign was to distract market participants from the obvious and inherent worthlessness of the U.S. dollar.
However, for the sake of argument, and because some people refuse to be convinced of the obvious insolvency of the U.S., let's pretend that there is still some underlying value to the U.S dollar, and let's return to our comparison of the U.S. dollar with the shares of a corporation. If you were the shareholder of a corporation, and management announced that they were going to issue trillions of new shares to “finance operations” this year, and trillions of new shares to finance operations next year, and trillions of new shares to finance operations the year after that (and so on), then (unless you're one of the deluded chumps holding shares of Citigroup), merely the intent to print-up all those new shares would cause you to instantly dump every share you owned – knowing that dilution would take the value of those shares down to only a small fraction of their value.
Thus, even if we pretend the dollar is not already worthless, we know as a simple function of arithmetic (not to mention 40 years of history) that the un-backed dollar will continue to shed its value at an ever-increasing rate. It will meet the same fate as every other “fiat currency” in history: it will go to zero.
Gold-skeptics will argue in return that gold “has no value”, either. Five thousand years of empirical evidence argues that such a conclusion is wrong. Unless one wants to devolve to a primitive “barter economy”, then each and every economy must have “currency”, and preferably “money” (i.e. currency that can retain the wealth of the holder) which can be used to conclude transactions in an efficient manner.
I have already listed the essential qualities of “good money”, and pointed out that gold is “good money”, because it satisfies those four qualities admirably. However, this is an understatement. In fact, gold is simply the best money our species has been able to devise in 5,000 years. In a society which must have currencies, the best money in existence is certainly a substance with enormous intrinsic value, both as a superior currency, and as an equally important store of wealth. People who hold mere “currencies” (i.e. paper money) are certain to lose a large amount of their wealth – simply by choosing to hold paper instead of money.
In a recent conversation I had with GATA's Adrian Douglas, he made a very astute observation – illustrating in the clearest possible terms how gold had demonstrated itself to be vastly superior to any other form of money. Even after 5,000 years of mining, refining, and fabricating gold into a plethora of coins, jewelry, and even “fillings” for our teeth, virtually every ounce of gold ever mined could (theoretically) be collected and stockpiled.
Unlike every other lesser metal (and every other substance) none of our supply of gold has ever been discarded into landfills, or simply “consumed” (as has occurred with most of our silver). For 5,000 years, gold has been such a vastly superior form of money that virtually every ounce has been conserved.
In short, we can state in theoretical terms why gold is the best form of money ever devised by our species, while thousands of years of empirical evidence demonstrates how it has been the best money ever devised.
In the last 5,000 years, we have gone to the moon, split the atom, and even cloned new life, but we have been unable to find or create a better form of money. As a species which prides itself on its innovative abilities, being unable to improve upon something over a span of millenia is the ultimate statement of quality.
Today's modern 'tulip-holders' are being given an opportunity which was not available to the deluded Dutch: they are being given a chance to exchange their 'tulips' for gold, before those 'tulips' collapse to their real value. Do not waste this “precious” opportunity!
1 comment:
Outstanding article, excellent information.
Mark
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