The Decline of the Pax Americana
"...For a period, Babylon advanced on a currency of silver equivalent to gold. But...[m]oney began losing its value, and confidence began to fall. Babylon’s wealth had been the foundation for its society. The economic crisis led to a civil war. The empire drowned beneath a tidal wave of debt...I fully expect that the U.S. Treasury and the Federal Reserve will continue -- like the empires before them -- to grow the number of dollars in circulation, an action that could push the Midas metal to $400 an ounce and beyond..."
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John Myers
-- Calgary
Every great nation reaches a zenith and begins an inevitable decline. The early signs of decay are difficult to recognize, most often because great powers maintain their military dominance even after they have reached their apex.
Consider Great Britain. In 1900 it was perceived as an indomitable power, the largest and most imposing the world had ever seen. The sun never set on the 12 million square miles of land that it occupied, and more than a quarter of the world's population lived under the Union Jack. And no power could come close to projecting the military power that England had at the time. The Royal Navy had more ships than the next two largest navies combined.
Yet Paul Kennedy writes in his book The Rise and Fall of the Great Powers that in 1900, Britain had already been in decline for 30 years.
"After 1870 the shifting balance of world forces was eroding British supremacy in two ominous and interacting ways. The first was the spread of industrialization and the changes which followed from it weakened the relative position of the British Empire more than that of any other country, because it was the established great power, with less to gain than to lose from fundamental alterations in the status quo."
In fact, British industrial rate of economic growth fell throughout the 19th century. Industrial production grew at an annual 4% pace between 1820 and 1840, then slowed to 3% between 1840 and 1870. Over the last three decades of the century, industrial output managed to increase by only 1.5%.
To counteract the decline, British imperialists were aggressive in their conquests of foreign lands and the confiscation of raw materials that lay within them. Yet the cost of the conquest and occupation of these territories was greater than the bounty that the Crown collected. By the early 20th century the strain on England's Treasury was noticeable. The British pound began a deterioration that would go on almost uninterrupted for about 100 years.
"From 1870 to 1970 the history of Britain is one of steady and almost unbroken decline, economically, militarily and politically," wrote Helmut Schmidt in his book, The Grand Strategy of the West. Yet Britain was no different than any of the other great powers that preceded it. As its influence receded, it began to debase its money.
But I think the best example of a government debasing money comes from thousands of years ago -- back in the time of the Babylonians.
Ancient Lessons for Today's Investor
Money was used by the Babylonians at least 3,000 years ago. With the implementation of hard money and budding trade and commerce, Babylon became the center of world power and wealth -- a city of gold. It's interesting that while Babylon attained prominence with a stable currency, it attained grandeur after it began to debase its money.
King Nebuchadnezzar devised a scheme where he leveraged the kingdom's gold to create much greater wealth. He issued IOUs -- loaning out at interest the great wealth from Babylon's treasury. The monetary stimulation doubled and then tripled the empire's wealth, producing the world's first economic boom.
But as the debt swelled, so did the claims on Babylon's wealth. Foreign claims from imports rose as well as domestic claims, exceeding the treasury's gold. Still the IOUs circulated. After a time, the swollen volume of debt caused people to demand more currency for their goods and labor. Inflation was in full swing.
Even as it took more money to buy the same goods, Babylon seemed to be economically stable. The treasury had lots of silver, and adroitly King Merodach-baladan extracted himself from the situation by declaring the value of silver equal to gold.
For a period, Babylon advanced on a currency of silver equivalent to gold. But an uneasy feeling that this situation was not quite right caused people to demand silver faster than they had demanded gold. Soon there was no silver in the currency. So copper was proclaimed to have value equal to silver. This didn't work because copper was in far greater supply than silver. Money began losing its value, and confidence began to fall. Babylon's wealth had been the foundation for its society. The economic crisis led to a civil war. The empire drowned beneath a tidal wave of debt.
Five hundred years later, the city-states of Greece were issuing metallic coins, the silver obol. After Sparta captured the Athenian silver mines around 400 B.C., Athens was faced with a grave shortage of coins. Over the next couple of decades, Athens issued bronze coins with a thin plating of silver. The shortage was made even worse as citizens hoarded the old coins and spent the new. It was the world's first experience of what has become known as Gresham's Law: Bad money drives out good money.
Imperial Overstretch
It was the emperors of Rome who used hard money to build the greatest political and military dynasty the world had ever seen.
Rome's wealth rose to glorious heights through conquest and little real commerce. In his book The History of Money, Jack Weatherford explains, "Rome's fame and glory came from the military and from conquest, and their riches, too, derived much more from the achievements of the army than from those of the merchants."
As long as Rome's legions conquered new lands, the empire thrived. But each new occupation required ever-greater resources.
In 130 B.C. Rome conquered the kingdom of Pergamum. In a few years, Rome's spending doubled from 25 million denarri (a Roman silver coin) to 50 million. By 63 B.C., the budget grew to 75 million denarri, and spending was beginning to spin out of control. Vast strategic ambitions and pork-barrel spending were beginning to sap the economic vitality from the Empire. By the time of Augustus, with Rome at its apex, spending rose to an astonishing 250 million denarri, or 10 times what it had been 60 years earlier.
Growing Ambitions and Debt
But even Rome could not surmount the Law of Diminishing Returns. By the time the Empire reached the British Isles, the cost of its army vastly exceeded the booty it was repatriating.
Yet spending continued to climb even as revenues declined. A string of emperors in succession pursued similar policies of currency debasement: collect coins in circulation and re-mint new coins with less silver content.
During his reign, Nero reduced the silver content in the denarri by 90%! Two hundred years later, there was no longer any silver in the coin at all.
Rome almost spent its entire reserves to prop up the government. Confidence in the money began to disintegrate. The Roman Empire imploded, crushed beneath its weighty ambitions and a mountain of debt.
In the book The Outline of History, H.G. Wells wrote, "Money was young in the human experience and wild. It fluctuated greatly. It was now abundant and now scarce. Men made sly and crude schemes to corner it, to hoard it, to send up prices by releasing hoarded metals."
Wells wrote this in 1920, at a time when the world was enjoying remarkable monetary stability. The gold standard was proving to be an outstanding regulator of monetary expansion and inflation. Since money was backed by gold, money could only grow at a rate equaling new gold reserves. Typically this was less than 1% a year (although there were some booms in gold production that greatly exceeded this number).
Gold was an instrument that took away the great powers' ability to devalue their currencies for political expediency. As the 20th century progressed, big governments with bold ambitions decided that the gold standard was unacceptable. That, of course, included the United States. After freeing itself from the gold "shackel" in 1972, the U.S. government was free to create as much money -- and therefore debt -- as it wanted.
The Connection Between Debt and Devaluation
At the beginning of 2003, federal debt stood at just a shade below $6.5 trillion. Ninety percent of this debt has been acquired over the past two decades.
In 1950, after a substantial debt buildup during the course of World War II, federal debt stood at just over $250 billion, or one-quarter of a trillion dollars. It took 24 years, till 1974, for federal debt to double to $500 billion. Total federal debt doubled again, hitting $1 trillion in just six years.
In other words, federal debt rose four times faster in the 1970s than it did in the 1950s and '60s. Federal debt hit $2 trillion in 1986 and stretched to $3 trillion in 1990. At that pace, the government was adding on $1 trillion every four years.
Runaway Spending
In the 1990s, Washington gave up on its public relations charade regarding a balanced budget. They had to, because federal debt levels were growing at an unprecedented rate. Every three years Washington spent a trillion more than it took in.
Debt brings with it interest charges. And even though interest rates are currently low, the sheer bulk of the debt has burdened the U.S. government with huge annual expenses on its debt.
Money that could be used for defense, education, city development or a myriad of other things is simply swallowed into a black hole. Interest charges to the federal government now total almost $300 billion, 70% more than interest charges in 1988. In the middle of this decade interest charges alone will top half a trillion dollars.
But the lion's share of the government's budget is spent meeting its domestic obligations. In 2003, Washington will spend $2 trillion! Of that, about $1.1 trillion will be spent meeting the federal government's social agenda (Social Security, Medicare, Medicaid). That leaves roughly $900 billion for everything else, but after interest expenses of $300 billion, Washington has roughly $600 billion, or just under a third of its entire budget to be spent on defense and foreign aid.
I fully expect that the U.S. Treasury and the Federal Reserve will continue -- like the empires before them -- to grow the number of dollars in circulation, an action that could push the Midas metal to $400 an ounce and beyond. Add that to a rapid divestment of foreign-held Treasuries or other U.S. assets held by foreigners, which could be catastrophic for the dollar, as well as the U.S. stock and bond markets. And, oh yes, it would send precious metals and other real asset prices into the stratosphere.
John Myers - son of the great goldbug C.V. Myers - has been helping readers earn suprisingly lucrative returns in stocks largely unknown to Wall Street's wunderkinder since his early 20s. Our man on the scene in Calgary, John has his fingers on the pulse of natural resource profits - including oil, gas, energy and gold. |
