Curse of the Philosopher’s stone

Alchemy is an ancient tradition with the objective of creating the fabled elixir – “The Philosophers Stone” which can turn any base metal into Gold. The paradox lies in the fact that Gold is such a time-tested store of value, because of its scarcity. The Philosophers stone would make gold more easily available (kind of like stumbling on a planet made of “gold” in space) and in turn devalue it to the point that it can no longer be used as a currency of exchange.

The scarcity of gold (among other things) has made it the preferred medium of exchange for many centuries. History is replete with the familiar pattern where kingdoms and governments have attempted to move away from a Gold backing and issue Fiat Currencies (paper), failed and returned to gold.

Gold does not allow for government/people’s aspirations. Irrespective of the political party, agendas can always do with more money. A fiat currency allows governments to print money at will to wage wars, fulfil populist measures like unsustainable entitlements (link) etc. Living beyond our means is so much easier when you can print money out of thin air. However this shift from gold to fiat leads to devaluation, inflation and a return to sanity.

Short Lessons in History

• • In Rome the Denarius (silver coins) were debauched by Nero in 1 AD. By 244 AD the content of silver in Denarius had dropped to 0.02%. They were refused to be accepted as currency.

• • The French issued ‘Assignats’ in 1790’s, they resulted in hyperinflation. Napoleon stabilized the economy by re-introducing gold.

• • During the Revolutionary war in 1775 ‘Continentals’ were issued to finance the war. They were over-issued to the point that they became worthless.

• • The Weimar Republic in Germany embarked on money printing spree to pay for the reparation costs of war ,which lead to a case of Hyperinflation in 1922-23

• • The Hungarian Pengo suffered the worst recorded case of Hyperinflation after the world war (1946). This was due to money printing.

• More recently in 2008 Zimbabwe faced a case of hyperinflation caused by a runaway printing press. The Money was used to finance a war in Congo by the Mugabe government.

The previous attempts of governments to use the printing press as the philosopher’s stone have resulted in currency implosions.

Typically when a country prints indiscriminately, the currency devalues against other currencies making imports costly. The US has an inbuilt mechanism that has sustained the demand for dollar. The Reserve currency of the world is used in oil trade and other international exchanges, this ensures a sustained demand for dollars.

Can’t we just stop printing now!?

1. 1. The US has borrowed from other nations to the tune of $10 Trillion.

1. 1. The US has borrowed from future reserves (social security trust) to the tune of $ 4 Trillion. This has resulted in an unfunded liability figure of ~ $100 Trillion. This means that an additional $100 Trillion is required to pay for the retiring baby boomers (after factoring tax income and outgo)

1. The US is already struggling to allocate capital efficiently, as evidenced by the real-estate bubble (2008). This means that there is very little manoeuvring room for the economy to grow at a rate high enough to meet the debts.

To stop printing money would mean a slow-down in the economy. If the creditors lose faith in the economy, bond prices will plummet and interest rates for all future borrowing can become prohibitively high, causing a default. No politician wants to be faced with this reality. The best way is to print and inflate away debts this has the unfortunate outcome of hyperinflation in the local economy.

The average life of a fiat currency is ~40 years; 15 Aug 2011 is the 40th Anniversary of Nixon closing the Gold Window…