I have always been a fan of old books, particularly Christian ones, but recently I found a new interest in old political and financial books. While at Goodwill this past week I found a book published in 1946 by Rollin G. Thomas, titled Our Modern Banking and Monetary System, which discusses the the banking and monetary system in the United States, one which has remained relatively unchanged since it’s publication. The old adage is true that those who don’t know history are doomed to repeat it and based on this premise I hope to at the very least be better prepared in the event that we do indeed repeat history.

I’m a very simple guy who over-thinks almost everything so my explanations can sometimes be oversimplified and yet complex. I tend to think of my own thinking process as being like a spiderweb which is actually very simple yet complex due to how it’s all put together. When it comes to our current financial crisis I have many thoughts on what caused the partial collapse of the entire world economy and what’s potentially ahead for the future.

There is debate on both sides of the political spectrum as to who was to blame for the housing crisis and I don’t care to go down that road again, but what happened is very obvious. Home mortgages were easy to get regardless of your credit worthiness and this resulted in a surge of people buying homes they couldn’t afford which then caused a surge in home prices because demand was artificially rising. This could not continue on indefinitely and eventually it all came to a crash in 2007-2008. To make things worse, we had have a government that can’t seem to stop spending money and just prints more when it’s convenient. Unfortunately this is not new to the the rest of the world.

The governments responsibility is to print money for use by it’s people, not it’s own use. If and when a government begins to abuse this power and prints money at will for it’s own use it results in a loss of confidence by the people who use it. It is not a requirement for money to have intrinsic value to be useful, but it is a requirement that those who use it in the exchange of goods and services have confidence in the fiat money. There comes a point where there is not enough money in circulation to meet the demand of the people and therefore printing more becomes necessary. When the money is paid back it is either re-loaned to others or removed from circulation if it’s no longer needed. This is all part of the design and purpose of the Federal Reserve in managing the nations money supply.

The idea of a central bank that manages the money supply is actually very effective when used as intended, but when the bank begins to print print money for it’s own purposes instead of meeting the needs and demands of the public, the public looses confidence in it and will look for other places to store their money. If this abuse by the government continues, the result will inevitably be a collapse of the currency. A while back I posted the following quote from the mid 1800’s which explains this phenomenon.

Nearly all the government paper issues ever made have shared the same fate as those whose history we have sketched. The phases through which they all pass is remarkably similar. The issue of paper money is generally resorted to by governments, as a resource to meet indispensable expenditures. This is contrary to the first principle of money, which is, that being an instrument made by the government at the expense and for the convenience of the individuals who use it, it should only be manufactured when demanded by the individuals. The principle which controls the issue of government paper money being false, like all other recourse to false principles, the issue cannot fail to be injurious to both government and people. No matter how despotic or popular the government issuing the paper money may be, the public soon lose confidence in it: if forced by legal enactments to accept it, they avoid holding it, and hoard the coin, in which they have confidence, and which, therefore, suddenly disappear from cirulation. The anxiety to exchange paper money, in which the community has no confidence, for commodities and other property which have an intrinsic value, soon produces a rapid rise of prices, which is the true indication and measure of the depreciation of all paper money having a forced circulation. Every rise in the prices, being in reality a fall in the value of the paper money, instead of inducing holders of commodities and property to realize, only increases their desire to retain their desire to retain them, whilst it increases the desire of the holders of paper money to exchange it for anything possessing intrinsic value. The inevitable result is a panic in regard to the paper money, and the very government that issued it is soon forced to refuse it in payment of taxes and loans, as it will no longer procure the supplies needed by the government and by its officers and employees.

…

Such are the terrible perturbations produced in communities by a forced cirulation of paper money. An inevitable fatality urges the Governments that use it, toward its abuse; for a forced circulation of paper money is always resorted to in moments of crisis, when the ordinary resources are insufficient. A first excess in the issue of paper money, rendered necessary by excessive expenditures, produces a depreciation in the value of the money received in payment of the taxes levied, and this depreciation obliges the Government to make further issues to augment its resources, so as to compensate the depreciation in the value of the taxes; and so on, ad infinitum, until the value of the paper falls to zero, which is equivalent to general or rather national bankruptcy.

When I first read that, I was taken aback at the accuracy with which it describes the current state of our government. I found it hard to believe that this was written over 150+ years previously and thus my interest in old financial and political books began. Today here I am writing about something which I am vastly inexperienced, but deeply interested in for reason I don’t quite understand. This very post was only intended to be about two sentences explaining a quote I wanted to post but even as I write I realize an important part of growing and learning from our mistakes is learning to articulate the thoughts and gut feelings that seem to fill our minds.

This past week, the United State Federal Reserve announced it would begins it’s second round of quantitative easing (Known as QE2) by purchasing 600 Billion dollars in debt from the treasury. For those unfamiliar with what this means, the Department of Treasury prints money via the Bureau of Engraving and Printing, which then sells it to the Federal Reserve. The Federal Reserve then turns around and buys treasury bonds and treasury notes from the Treasury. Confused? Think it’s insane? It is and it’s this insane practice and which has caused people to loose confidence in the dollar and therefore it becomes devalued.

This brings me to the topic of inflation, which I intended to write about from the beginning. It is a common misconception that higher prices is the result of inflation, but higher prices are really just a symptom of Inflation. Many people are familiar with the Supply and Demand model which says if the demand for a product and/or service rises but the ability to meet the demand is not possible, the result will be higher prices. In this case the value of the money stays the same, it’s just the cost of a particular item has gone up because demand is greater than the supply. This is a normal and healthy part of our economic system. Inflation occurs when the value of money falls and thus more of it is required to purchase the same as before the fall in value. For example, if I am able to purchase a gallon of milk for $3 but then the value of my money is devalued to half of it’s original value, I will now need to use $6 to purchase the same thing. In this example the money did not stay the same and I now need more of it to purchase the same amount. The difference with inflation is that just about everything will rise in price, but with the  supply and demand model, only those products and services where demand exceeds supply, the price will rise.

The U.S. government has been abusing it’s power and printing enormous amounts of money to fund it’s spending which has caused people to loose confidence in the dollar. This lost confidence causes the dollar to fall in value because no one wants it. When the value falls, it requires more of it to purchase the same as before it fell in value. So what does this mean for us? With this recent announcement of QE2, the already weak dollar will be devalued even further and thus prices will rise. At this point depending on who you listen to, the dollar is expected to loose another 30-50% of it’s current value. If you’re still asking what does that mean for you, it simply means the dollar will either collapse or prices of products and services will skyrocket to unbelievable levels.

I’ll share a little later what I’ve been doing to prepare but let’s just say for now that you should get your savings out of the dollar and put it into things of intrinsic value like precious metals and commodities. I would also suggest you avoid things like CD’s.