Here we go again.
Not satisfied with the effect of massive money printing during the 2008-09 financial crisis, Federal Reserve chairman Ben Bernanke recently unleashed a second round of “quantitative easing.” In so doing, he has laid bare America’s dollar debasement strategy.
The government of the United States is now funding its entire $100 billion per month budget deficit through printing money to buy its own bonds. Were it not for the necessity to ensure that Wall Street’s bonus pool stays filled, the Fed might as well cut out the New York middlemen and just dispatch trucks around the country loaded with “Benjamins.” The effect is the same.
Canada, unfortunately, is not insulated from such madness. Our economy is integrated with the United States. Our total debt burdens and financial pressures are more or less the same as Americans. We may not be driving the debasement express, but Canadians are still very much its passengers. The investing playbook for this era of quantitative easing is fairly straightforward. Avoid anything that looks like a government bond and buy things like wheat and silver, which represent relatively cheap, hoardable commodities. But while hoarding maximizes an individual’s returns in 2010, it strikes me as a rather dubious economic strategy for the country as a whole. In order to pull out of this spiral, I believe we need to reconsider our disdain for gold-backed money.
Many people do not realize that this country has a long history of operating on a gold standard. The Canadian dollars of Confederation were exchangeable into 23 grains of gold.
Between 1933 and 1971, Canada ran on a kind of second-hand gold standard. The U.S. dollar was convertible to gold at $35 per ounce, and the Canadian dollar was managed to a reasonably narrow range against the U.S. greenback.
The beginning of the end for Canada’s hard currency was December 1966, when Finance Minister Mitchell Sharp announced that coins of the $0.10, $0.25 and $0.50 denominations would no longer contain their long-standing mix of 80% silver and 20% copper. Loose fiscal policy in America related largely to the Vietnam War had caused the coins’ silver value to pass through their face value. By 1968, the deed was done. Silver coins were dropped in favour of the slugs that continue to be stamped out by the mint at the cheapest practical cost.
In 1971, America’s war borrowing eventually led President Richard Nixon to abandon the gold convertibility of the U.S. dollar. Canada’s implicit gold standard, already imperilled by the end of silver coinage, died simultaneously. So if you ever wondered who really decided that Canada should have completely faith-based fiat currency, the answer is Richard Nixon. Such irony.
A fiat money world is characterized by its bubbles and bailouts. Asset price bubbles sooner or later give way to consumer price inflation. And savers, burned by popping bubbles or high inflation, become hesitant to make long-term investments at any price.
The key advantage of a gold standard is that the supply of money, and credit, can only grow in proportion to the growth of physical gold reserves. Given that we already have many centuries worth of production stored above the surface, this effectively limits the growth of money at most to a few percentage points per year. With credit growth thus constrained, the emergence of debt-fuelled bubbles such as the dot-com fiasco or the various housing bubbles would have been well-nigh impossible.
The re-adoption of a gold standard would not be easy. It would make the adjustments related to the HST look like a walk in the park. Yet the alternative, to do nothing and twist into inflationary chaos, seems far worse. As an investor, my bets are placed squarely on the do-nothing option. But as a citizen, I recognize that there is a proven, workable alternative. Can we really trade our bubbles and phony cash for “change we can believe in?” The answer is clear. Yes we can.