A question came up about whether fiat money systems always fail. Some have made the argument that fiat systems don’t always fail and that something like a gold standard is worse.
I think those that make this point need to understand that a fiat money failing usually goes hand in hand with the government failing at the same time. In fact, hyper-inflation is the final gasp of most dying governments. Very few come out of the situation intact because the markets lose confidence and dump their currency to whatever sucker will pick it up.
Consider this, how many governments still exist today that existed 100 years ago out of hundreds of countries?
By my count, maybe six? U.S., Canada, Britain, New Zealand, Australia, Switzerland? Feel free to add any I missed in the comments. I’m not saying countries, I’m saying the governments over those countries and the money they issued. For instance, Germany today is not the same government it was 100 years ago obviously and the currency back then is worthless today. This is true for most countries on this planet.
In fact, the older a country gets, the more likely it is to have problems, not less. The U.S. is well over 200 years old. It is the outlier. It’s never good to be the outlier. So in terms of the dollar having serious problems, the odds of it happening go up each year, not down.
But the point is that when a government went away, often so did the currency they issued. No incoming government is likely to honor the debts and financial obligations of the old and will want to start anew. So in many cases where governments changed, chances are very high the money either became worthless, or lost a tremendous amount in value during the transition. It would be very unusual for a fiat money not to to experience either total or very deep loss when this happens.
What this means is if you’re playing the odds (and if you invest you are), then a catastrophic currency problem in one’s lifetime is actually quite high. Look at that number above about countries that have survived with intact governments the past 100 years and really think about it. It’s remarkable how unstable governments are in this world.
In fact, the older a country gets, the more likely it is to have problems, not less. The U.S. is well over 200 years old. It is the outlier. It’s never good to be the outlier. So in terms of the dollar having serious problems, the odds of it happening go up each year, not down.
I’m not being Chicken Little here, just looking at what history shows us so it’s best to be diversified.
I would argue that each year the dollar doesn’t have a problem is another year that it’s more likely to have problem going forward. I guess you’d call it a fiat currency paradox. At least, that’s what I’m calling it.
Just something to consider when someone says to you that fiat money is fine no matter what. It isn’t. It’s a good idea to hedge against the reality that fiat money won’t work forever and you don’t know when things could go wrong.
This is a very good post. The only country I can add to that list off the top of my head would be Sweden.
Yes I was thinking Sweden also, but not sure about the history of the Krona. I think they even used paper money in the past early on and it blew up as well. They were on a bi-metallic standard for a while as well.
So maybe we’re at seven countries now? Let’s just call it less than 10 worldwide from my thinking on this. So less than 10 countries today have a government (and probably currency) that was around 100 years ago. Still pretty bad odds.
On reflection I am not sure any of the pre-World War I currencies cited still exist as they did then. The names may be the same but it must be remembered that all of these countries were on the classic gold standard. That meant that gold was money and terms like pounds francs dollars kronar etc. were merely a reference indicating how much gold we were talking about. The old US Dollar arguably died in April of 1933 when FDR abandoned the gold standard and repudiated America’s gold backed bonds. It is astonishing how many people keep repeating the obvious falsehood that the United States has never defaulted on its debt. Try taking a pre-1933 US Bond to the Treasury and redeeming it for gold as promised at $20.67 oz and let me know how that works out.
And of course the currency changed again in 1971 with the abandonment of Bretton Woods. From an historical perspective the US Dollar in its present incarnation is only about 40 years old.
Craig,
Very interesting read.
How much of a safeguard will the stock portion of the PP be against hyperinflation and/or currency failure? Or will we solely look to the gold portion for that protection?
Ad,
You are correct in the technical sense about things like the Dollar, etc. not being the same. But technically, I could still take a $20 gold certificate note from 100 years ago and probably exchange it for a new $20 not today (or sell it for much more to collectors). So I would still think things like the US, Canadian, New Zealand, Australia and British currencies are still technically continuous, even though you are right that they are much changed. At least those governments are still around so that’s a start, right?
Jon,
Hard to say what gold would do. Nothing is perfect. But if the dollar were to go on the ropes the exit doors would be mobbed. People would be scrambling for anything non-dollar (including gold).
Stocks have a way of surviving hyper-inflations oddly enough. Companies are hard to kill if you have a good management on board and they are creative. Even in Germany you had companies survive their very bad war and still be around today (Mercedes, etc.).
But if something that extraordinary were happening, I would suggest as an investor you don’t rebalance back into bonds and weigh the situation at hand!
if you look at inflation the dollar has already been devalued a great deal…just look what a dollar bought 100 years ago…fast or slow the politicians use inflation to beggar the masses without their realizing it…IMHO of course.
printing money is so much easier than raising taxes or balancing the budget…..
When the US Dollar finishes its trip into the dustbin of history, gold will still be valuable.
In fact, it is extremely likely that gold will be the basis for the next world reserve currency, which will require a much higher purchasing power for gold.