This is the second part of a five part series on how gold will return to the monetary system globally but not in the form of the defunct Gold Standard.
What Alan Greenspan said still holds true today. But now we have to replace welfare statists for central banks and other financial institutions, in a global world. We see it in the financial debt problems of nations, of individual states in banks and in many corporations as many wobble in the face of bankruptcy. The issue of more currency either through swaps to the Eurozone or though quantitative easing in the U.S. has neatly postponed the problem but in doing so has exacerbated it. The banking crisis has been alleviated but the national debt problems have not yet been alleviated. Even the U.S. with a debt to GDP level of 90% is such a candidate.
So Far, So Good
However, until today the system has worked well as everyone accepted the dominance of the dollar. Surely the control the U.S. has on money through its grip on oil will hold and allow such profligacy? There is no doubt that citizens can be made to obey governments through the rule of law. Citizens are dependent on government for the issue of sufficient money to create a thriving economy which provides all that they want. Even if money has ceased to represent a reliable measure of value, citizens can be forced to use it. Inflation is eventually beyond the control of governments and citizens when it truly reflects profligacy, but in the interim, a postponement of such consequences can be achieved.
Today we face the two almost compensating forces of inflation and deflation. Deflation diminishes asset values through falling prices. Inflation diminishes value through rising prices. When they strike together, they can be made to appear that stability is achieved, with low net inflation and low net deflation. But this is a dangerous balancing act that can after a while, turn very mercurial. Central bankers fear deflation more because deflation can sap economic activity, whereas inflation, when relatively low, does not. But if deflation falls away as an economy sees a recovery take hold convincingly, then inflation is unfettered. That’s when central bankers have to do as they did in the mid-eighties, when U.S. interest rates leapt to 25%+ and killed inflation. That was successful because the economy was strong and robust, taking the blow in its stride.