"The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists."  
—Ernest Hemingway

Following Mr. Hemingway's list, let us consider the inflation of the currency first. The points to consider are: why we should consider it, what makes it produce temporary prosperity, what are the consequences for permanent ruin, how to protect yourself in the event of a costly inflation, and when to expect it.

Then we'll take up the matter of war: how it affects the economy, what economic events might be forthcoming during the war, how to protect your interests, and when to take action. It seems clear that the issue of whether to have war is well in the past now, and is a political matter about which you are free to agree, or disagree.

WHY CONSIDER INFLATION?

You may very well ask yourself why inflation may be a worry. After all, we are in the midst of a number of indicators of deflation.

The first thing to remember in considering inflation is that it has previously been adopted as an economic policy in the United States. Twice.

In 1933, President Franklin Roosevelt ordered the devaluation of the U.S. dollar from twenty dollars per ounce of gold to thirty-five dollars per ounce of gold. He also ordered the immediate exchange of all privately held gold at the new rate. He ordered the subsequent seizure of all privately held gold that was not exchanged at the new rate after a set period of time. These policies were all reflected in his executive orders of March 1933.

The historic justification for these events were economic chaos. Indeed, the Congress authorized emergency action with the declaration of a national banking emergency. In theory, a national emergency justified actions which would otherwise be forbidden under the constitution (e.g., the taking of private property such as gold for public use without due process or just compensation).

Naturally, it was Congress which had first inflicted economic chaos in 1929 by having the votes to pass over President Hoover's veto the Smoot-Hawley tariff act. The imminent trade war caused the dramatic drop in the stock market, taking huge amounts of liquid capital out of the economy. The trade war itself left American goods rotting at the dockyards, while foreign goods were much more costly. As a result, there were very few dollars available.

Exporters had fewer dollars because retaliatory tariffs had made American goods unwelcome in foreign ports. Importers had fewer dollars because the Smoot-Hawley tariff made imports very costly while placing most of the new higher cost into the Treasury. Consumers had fewer dollars because foreign goods were now very expensive. Stock owners had fewer dollars because the stock market had crashed in anticipation of these difficulties. Tens of thousands of workers were unemployed as plants shut down. Eventually, as much as a third of the work force was out of work. So, none of these people had any dollars.

With so few dollars available, and so many goods unwanted for export, there was a dramatic deflation. The economy crashed. Prices fell as sellers tried to gain any money for their goods. With less money from sales, they let more workers go, with a vicious cycle persisting for years.

During this period, veterans of the First World War marched on Washington, pleading for the bonus they had been promised which would be paid in 1945. The so-called Bonus Army wanted the bonus to be paid immediately, during the economic chaos. The marchers were unarmed and offered no threat, but were brutally suppressed by military action.

Also during this time, the Federal Reserve acted foolishly. With the economy reeling from lack of liquidity, the Fed raised interest rates. The new higher interest rates were supposed to prevent further speculative excess on the stock markets, but that was closing the barn door after the livestock had fled. Subsequently, the Fed lowered interest rates, but deflation was faster and the real interest rate peaked at 15 percent in early 1932. The unintended consequence was to make borrowing impossible for most people in the economy.

Bank foreclosures became common, as banks tried to repay funds on deposit. But, the foreclosed properties brought very little at auction, so banks began to see huge runs. A run on the bank happens when the depositors try to get their funds out, only to learn that the government policy allowing fractional reserve — lending out of more money than is on deposit - makes it impossible for any bank to satisfy all depositors at once. Many banks went under and closed their doors forever.

The economic chaos of 1929 to 1932 ended the chances for President Hoover's re-election. As a result, a new president took office on 4 March 1933. He immediately called for Congress to declare a national emergency, which they did. He then undertook a large number of inflationary measures - putting more dollars in circulation.

The forcible conversion of gold to dollars at a significantly devalued rate was one of these policies. The currency was devalued by 75% - from $20 to the ounce to $35 to the ounce. Other policies included government spending without taxation — deficit spending— on public works projects. A new Social Security program was instituted to pay to retiring workers a monthly stipend— even though they had not paid anything into the system.

History shows that these various inflationary efforts were lackluster in their performance. The economy recovered slightly, then suffered further recessions. Eventually, President Roosevelt moved to the other panacea, and by 1938 had begun to involve the United States in actions both in China and in Europe which eventually led to the entry of the United States into the Second World War. Again, as a political matter, this policy had merits. But politics is not our concern here.

The post-war economy was very vibrant. The mainland US had never been bombed, so it had intact production while Europe and Asia were still re-building. The economic success had been aided in part by the Breton Woods agreement which set all post-war currencies to exchange in U.S. dollars and provided that foreigners could exchange their dollars for gold at the rate of $35 to the ounce troy.

However, this policy would not last long. By 1964, it was obvious that the repeated efforts to fix the price of silver were failing. Silver was taken out of the dime and quarter. In 1968, silver was removed from the remaining coinage. In other words, the common coin of the realm was debased.

Also in the late '60s, the exchange rate of $35 to the ounce was unsustainable. A military airlift of gold from the United States to London to pay off exchanges of dollars for gold was so hefty it broke the weighing floor of the London gold exchange. The exchange rate was lifted to $38 per ounce, again devaluing the US dollar. That didn't work, either.

In 1971, President Richard Nixon ordered the end of the redemption policy. U.S. dollars would no longer be redeemed for gold. Again, acting under authority of the 1933 National Banking Emergency declaration, he instituted this policy by executive order.

As expected, the policy led to dramatic inflation. To address this inflation, the Nixon Administration instituted wage and price controls. They also blamed the inflation on the oil embargo in 1973. However, the underlying policy of debasing the currency and refusing redemption in gold was the real cause. The Ford Administration tried to blame it on housewives and shopkeepers, with their "Whip Inflation Now" program to encourage thrifty shopping.

In 1976, two important events coincided with the Bicentennial of the Declaration of Independence. Americans were again able to lawfully purchase gold with President Ford lifting the decree from 1933 which had forbidden Americans to own gold. Also, Nobel laureate economist Friedrich Hayek published The Denationalization of Money to provide effective economic commentary on these critical matters. Hayek called for free market money, a call which has lately been answered by e-Bullion.com.

By 1979, the inflation rate was over 20% annually for some quarters. It was then time to change the economic policy or face hyperinflation. The Federal Reserve raised interest rates very high, and the economy stuttered into recession. You'll recall in early 1980, gold reached an intra-day high of nearly $895 per ounce.

Inflation had been beaten back, but the economy was dead. Again, economic chaos led to a change of political control. President Ronald Reagan instituted a policy of massive tax cuts which were very effective at stimulating growth. In fact, from 1982 to 1999, the economy grew in real terms in one of the longest bull markets in history.

To summarize, inflation was a deliberate policy chosen in 1933 and again in 1964. While it did not work effectively to improve the economy, it did result in higher gold prices each time. The effects of hyperinflation were avoided by changing the policy - in the 1940s by agreeing to redeem dollars for gold in the Breton Woods accord and in 1982 by dramatically cutting taxes.

THE LURE OF TEMPORARY PROSPERITY

Throughout history, inflation has had an allure for economic policy makers. In 1789, France celebrated renewed liberty under the monarchy with the storming of the Bastille. Frenchmen celebrate Bastille day every 14th of July.

They don't celebrate the subsequent Reign of Terror, which led to the guillotining of King Louis, his wife Marie Antoinette, many of the nobility of France, and most of the leaders of the Revolution. The Terror was the result of a terrible economic policy taken by the new French government in 1789, sadly mirroring an earlier economic policy taken by the Continental Congress.

In November 1789, the new National Assembly seized all the private property of the Catholic Church in France. This property was then used to supposedly back an issue of paper money, 400 million "livres" of assignats. The assignat was a fiat money, the first issue of which bore the likeness of then-ruling King Louis XVI.

The result was a temporary prosperity. The new currency was widely accepted, even outside of France because of the perceived significance of the King's approval. The economy recovered from the recent depression and the new money restored the bankrupt finances of the national treasury.

However, the allure was too much. Although key legislators in the Assembly who had voted for the first issue had warned against any further issues, the appeal of the temporary prosperity was too powerful. In September 1790, another 800 million livres of paper assignats were issued. In 1791, a further 900 million were issued. Runaway inflation was now overwhelming the economy.

In 1792, riots returned to Paris. The royal family was imprisoned. A further one billion three hundred million assignats were issued. Attempts to redeem them for confiscated church property were rebuked. Shopkeepers began to price goods separately in silver or gold, and assignat prices went skyward. With 3.4 billion assignats in circulation, the new Legislative Assembly agreed to recall 600 million which were destroyed.

The year 1793 began with the beheading of King Louis and ended with the beheading of Marie Antoinette. In between, a further 1.4 billion of assignats were issued. Price controls on grain were instituted, immediately causing all grain to disappear from the markets. When informed that people had no bread, Marie Antoinette naively asked why they didn't eat cake instead. Trading in specie (gold or silver coin) was forbidden by decree. In September 1793, the law of the maximum decreed price controls on all food - all food became very scarce.

By the end of 1794, Robespierre had been elected and beheaded, the Reign of Terror was official, and seven billion assignats were in circulation. In 1795, over 35 billion assignats were in circulation, the economy was in ruins, and the Directory had taken power.

By early 1796, 40 billion assignats were circulating. The machinery for printing the assignats was destroyed by government mandate. However, rather than returning to specie, the new government imposed the mandat, accepting 30 assignats for every mandat issued. By August 1796, the mandat was worth only 3% of its face value, just six months after its arrival on the scene. The original assignats with the King's face traded at about 10% of face value.

In May 1797, the legal tender attributes of both mandats and assignats were withdrawn. Both paper money currencies became worthless. Specie came out of private stockpiles immediately, but the damage to the economy was done. Napoleon Bonaparte began winning victories overseas in 1798, and on the 10th of November 1799, he seized power "to save the Republic."

My source for this information is the book Fiat Money Inflation in France by Andrew Dickson White, printed by the Foundation for Economic Education in 1959. White wrote his book in 1876, after founding Cornell University and becoming its first president. You can contact the foundation at http://www.fee.org/ for more details on buying this book.

PERMANENT RUIN

In case my examples from the last newsletter of fiat money inflation in England and the John Law fiat money in France producing the South Sea Bubble and the attendant depression from 1722 to 1782 were not convincing, the above example of fiat money in Revolutionary France should be more compelling.

How do you prepare for inflation? You buy gold. You might wish to have some silver coins on hand, as well. Small denomination purchases will work well with e-Bullion or with silver coins. Gold is always able to buy whatever paper money is on hand.

Naturally, Goldfinger Coin and Bullion wants to sell you gold. We want you to be safe in the future, and the prospects for people experiencing hyperinflation who don't have gold are very poor.

In our last newsletter, I suggested that you should celebrate Independence Day by resolving to buy an ounce of gold with every paycheck, or at least once a quarter. You can buy excellent quality gold coins here at Goldfingercoin.com or you can buy gold at e-Bullion.com and let us handle the storage for you.

Remember that the price of gold rose dramatically during the last two periods of inflation in the United States. You can expect your gold to appreciate against the dollar in future inflations, too.

WHEN TO EXPECT INFLATION

Timing is everything. I don't have a crystal ball, and I don't pretend to know the future. I do know that political conditions are once again ripe for a change in monetary policy.

What motivated fiat money in Revolutionary France and Weimar Germany? It was motivated by the bankruptcy of the national treasuries. What about the inflation policies of Roosevelt? They were motivated by the bankruptcy of the national treasury. Johnson-Nixon-Ford faced the same difficulties as they tried to pay for the Great Society, the Vietnam War, and an exciting Moon race.

If you examine the national indebtedness presently, you see the same problem. There is admittedly a federal government debt of some six trillion dollars. Add to that state, local, and personal debts, and figures in the tens of trillions are reached. Add the unfunded obligations of future payments to Social Security and Medicare beneficiaries to come, and the total reaches a staggering $44 trillion.

Debt is manageable as long as the interest payments can be met. So far so good. But with annual interest payments in the hundreds of billions, the manageability becomes questionable.

We even see signs at the Federal Reserve that the current monetary policies aren't working out. A recent essay Monetary Policy in a Zero-Interest-Rate Economy by Evan F. Koenig and Jim Dolmas proposes that open market operations and currently very low interest rates are not providing adequate stimulus. The very modest tax cut just passed seems unlikely to be sufficient. Koenig and Dolmas propose all kinds of alternatives, including a new Stamp Act requiring that all currency be stamped monthly at a cost of 1% per month - an effective negative interest rate of 12% per annum!

Koenig and Dolmas also propose purposeful currency depreciation by buying foreign currency reserves. In other words, pursuing a policy of inflation. They suggest monetizing new debt of the federal government, which is again an inflationary policy.

In other words, the Federal Reserve is now considering a variety of deliberately inflationary policies. While these policies have not yet been implemented, the implication is clear: the time for inflation is once again near at hand.

Given their previous performance, deleting 96% of the value of the dollar since 1913, one can only expect inflationary policies under the Federal Reserve to spiral out of control, once more. If Revolutionary France or Weimar Germany are any gauge, we can expect 99.9999999% of the value of the dollar to be deleted before the Federal Reserve note is abandoned for a new currency.

The War Economy Since September 2001, the United States has been pursuing a war against terrorism. Again, the political reasons for this war are not questioned here.

The economic effects are significant. War stimulates defense sector companies. A number of these have done very well in recent months. War increases demand for certain strategic minerals and other commodities rise in line. For example, during the early fighting in Iraq, gasoline prices went up dramatically. They remain inflated compared to pre-war prices.

By itself, war is an inflationary policy. It reduces the domestic available labor pool by sending working age personnel overseas to fight. Sadly, many of these men and women never return. We should remember them as we celebrate national holidays. War increases demand for certain products and services. It often stimulates economic responses by other countries.

TRADE WARS

One of these economic policy responses is the trade war. Countries which opposed the war in Iraq such as France and Germany were significantly alienated by US policy. American policy makers called on Americans not to drink French wine or consume products from either country. Even the names of popular foods were proposed to be changed, though one can imagine that politicians in Idaho were not eager to see a reduced consumption of "French fries" given their local potato economy.

In 1973, the Arab nations responded to U.S. support for Israel in the war there by instituting an embargo on oil for America. The resulting price shock caused long lines at gas stations, increased the pressure for further wage and price controls, and exacerbated the existing inflation.

One of the very interesting policy responses has come from Malaysia which was recently joined by Iran and a number of Arab nations in their pursuit of a gold dinar policy for international trade settlement. 

With a gold dinar in circulation as a currency for settling international trade balances, these countries no longer need as many dollars for the same settlement functions. If OPEC were to adopt the euro or the gold dinar as the currency for settling oil contracts, the effect would be even greater.

Where do those dollars that aren't needed in international trade go? Well, they are promptly spent for American products, or otherwise returned to the United States. That means more dollars here chasing the same quantity of goods and services. In other words, it means inflation.

As much as two-thirds of the U.S. dollars are in the hands of people in other countries. Thus, the potential for inflation if these are no longer used in international trade would be enormous.

Presumably part of Iran's enthusiasm for the gold dinar concept is to limit its dependence on US dollars for trade settlement. At the same time, the US government is apparently not opposing the policy. Perhaps the U.S. policy response is in part motivated by a desire for further inflation.

PROTECT YOURSELF — BUY GOLD

With war, trade wars, and a looming policy with both the monetary policy makers at the Federal Reserve and the fiscal policy makers in Washington favoring inflation, your course is clear. You can best protect your interests in the coming months and years as inflation moves from policy preference to policy practice, and from minor to stagflation or hyperinflation, by buying gold.

THE TIME IS NOW

The time to buy gold is now. The recent drop in price from the $370 level has shown strong support at $350. Prices should rise further, soon. So, you should buy while prices remain low.

Keep on buying gold until it represents at least 15% of your portfolio. Remember that it is liquid wealth. It will be available for sale at any time you need access to that wealth, whether today or ten years from now or centuries from now when your descendants need money (and with the inheritance tax on the way out, you should really think hard on that matter).

Gold is good when money goes bad. Or, put another way by yet another brilliant writer,