In this special five part series, we’re exploring the reasons gold remains the only shield against boom and bust cycles. In part three, we’ll briefly look at why policymakers are typically the catalysts of boom and bust cycles. And we’ll explore what role gold can play in preventing such crises.
Why Credit Expansions are Never the Answer to Economic Problems
Every single credit expansion in history has met the same fate: the collapse of an economy. At its worst, these crashes have wiped out entire civilisations.
This isn’t something up for debate.
From the Egyptians to the Romans and all the way through to modern societies, credit expansions have always ended in disaster. And the existence of modern financial instruments today doesn’t change this either.
Despite numerous examples throughout history, people are mostly ignorant of the true effects of credit expansions. Many believe that, not only are such policies harmless, they’re actually necessary for economic growth.
These people couldn’t be more wrong. But we can’t blame them. We’ve been conditioned to think exactly that.
So where did this idea that credit promotes prosperity originate? It’s actually been with us for millennia. But in contemporary economics, the idea gained traction only relatively recently.
Popular 20th century economist John Maynard Keynes was a big proponent of government-led credit expansionism. His school of thought is largely responsible for the wave of new money creation in the system we see today.
Keynes advocated printing money — known as stimulus spending — as a response to economic slumps. However, printing your way out of trouble, as we’ll see soon, is something that never bodes well for an economy in the long run.
The only reason we allow these policies to go on is because we place too much trust in governments and central bankers.
We are fooled into believing their policies are in everyone’s best long term interests. But we know that’s not true.
They can’t pile up debt forever without risking the value of the very currencies they control and seek to protect. That’s especially true as these currencies aren’t backed by anything tangible, such as gold.
The GFC that ignited in late 2007 should have been our own wakeup call. Instead, it just led to more debt accumulation, propping up waning economic growth rates. This wave of credit expansion is now tied up as collateralised debt in overvalued assets like real estate.
Ultimately, our faith in paper currencies, at the expense of gold, is leading us towards disaster.
But is doesn’t have to be this way. There is a way out.
If the ruling elite ever let economies peg currencies to gold, boom and busts would be a thing of the past.
Gold is a viable currency peg, as long as the system isn’t abused
Recently, our chief editor at Markets and Money, Greg Canavan, made an interesting observation about currency pegs. He suggested all currencies meet the same eventual fate: collapse. And he was equally critical of gold in his assessment of pegs.
Greg isn’t a gold sceptic by any means. But he’s doubtful of its effectiveness as a makeweight for currencies. He believes that fixing currencies — to anything — only leads to economic crises. Greg explains:
‘Going back into the past, the booms and busts and constant banking crises in 19th century US had much to do with the “fixing” of gold and silver to dollars. It led to monetary lurches from one side to the other, causing havoc in between.
‘Fixing the value of currencies to anything is a recipe for disaster. If you look closely enough, economic history shows that fixing currency values is the source of many economic problems.‘
Of course, it’s true that boom and busts have been a constant throughout history. But it’s equally true that currencies, pegged to gold, have disappeared.
But we should draw a distinction between cause and effect.
Specifically, there needs to be a connection that a gold peg could result in a currency collapse. Yet there’s no evidence of anything of the sort ever happening.
Rather, currencies, tied to gold, have collapsed because those in power started to abuse the gold peg.
If anything, gold has done its job too well; so much so that governments have had to retool the entire system just so they can keep spending.
In theory, a gold peg — or standard — works because it prevents currency inflation. In practice, societies find that once they need more currency, the gold standard stops being useful.
This has been true right throughout history.
The biggest cause for abandoning gold standards has been the need to fund expensive wars. Yet, as many leaders have discovered the hard way, gold is both scarce and finite. You can’t print it like a paper currency.
Gold prevents the expansion of reckless currency supply. Under gold standards, you can’t pump more currency into a system if there’s not enough gold to support its expansion.
So what options do policymakers have in addressing this?
We’ve seen one scenario play out time and time again: the debasement of the gold standard. And perhaps there’s no better example of this than the Romans. Join us in Part Four tomorrow as we look at how Rome’s monetary expansion coincided with its downfall.
Junior Analyst, Markets and Money