Stealth Bankruptcy

by Tom DiLorenzo

I recently had an e-mail exchange with a person who scoffed at the idea that the United States had declared bankruptcy every time it revalued the price of gold upward and when it "went off the gold standard." I came up with the following hypothetical example which is a parallel to U.S. monetary/gold history in order to illustrate my point. Judge for yourself the actions the United States has taken with regard to its foreign debts.

And no, I never did receive a response to this last e-mail. Ah, well...

Parallel Example

Saudi Arabia prints up a currency called the Petro, and declares that 1 barrel of oil equals 20.67 Petros. The Petro also will be the new unit of account for Saudi Arabia, and all taxes and payments to the government must be made in Petros.

From the 1834 to 1934, 1 troy ounce of gold was officially worth $20.67.

World markets now utilize Petros, a way to deal in oil without actually taking delivery of the commodity. Of course the currency circulates and holds value primarily because the countries holding Petros can exchange the currency for actual oil.

Let's say France accepts and holds 20,670,000 Petros in lieu of actual delivery of 1,000,000 barrels of oil.
The Saudis then declare that they are "increasing the value of oil," by now making 1 barrel of oil worth 35 Petros.

France's 20,670,000 Petros can now be exchanged for 590,000 barrels of oil, for an overnight 41% net loss of 410,000 barrels.

Question: How is this not a default? Is oil suddenly more valuable or is the Petro suddenly worth less? Based on what?

In 1934, Roosevelt revalued the dollar from $20.67 to $35 per troy ounce of gold. Any foreign nations holding dollars would now receive less than 60% of the gold that those dollars were worth the day before.

The nations of the world accept the shaft, but soldier on. After all, they need oil. As Saudi Arabia continues to print up more and more Petros, the other nations begin to wonder if there really is enough oil to cover all the notes. Less and less nations are willing to hold on to the notes for any extended time, preferring instead to exchange them ASAP for oil.

Saudi Arabia then declares that it is "closing the oil window" and disconnecting the Petro from oil because international speculators have been attacking the currency. The Petro will now float on the open market, but the Saudis will no longer accept Petros in exchange for oil.

Question: How is this not a default?

In 1971 Nixon "closes the gold window," making the dollar irredeemable in terms of gold. Foreign nations holding dollars, which had the solemn pledge and the full faith and credit of the United States of America that their held dollars were exchangeable for gold at a $35 per 1 troy ounce rate, now could no longer be exchanged for gold.

The Petro retains some market value because the Saudi government will accept it as payment for everything except oil. The world will have to go get its oil from other countries. The Saudis are pretty much sold out. The market discounts the Petro appropriately.

The free market gold price rose above the official price in the late sixties and then soared throughout the seventies. This is the exact equivalent to saying that the market value of the dollar slowly diminished in the late sixties and then dropped precipitously in value during the seventies.

Then, just for kicks, the Saudis increase the value of oil to 38 Petros a barrel, and then to 42.22 Petros a barrel. These new values represent the official prices for which they refuse to sell oil.

Nixon revalued the dollar to $38 per troy ounce in 1972, and then again to $42.22 per troy ounce in 1973. These were the new prices at which the United States government refused to sell gold.

And whatever oil the Saudis still have, the government still values it at the officially decreed 42.22 Petros per barrel, even though it takes 1,000 Petros to buy a barrel of oil from any other supplier.

Recent gold prices have been close to $1,000 a troy ounce. The United States Treasury claims that the gold it owns is valued at $42.2222 per troy ounce. The market does NOT dictate to the government, dammit! See
http://fms.treas.gov/gold/index.html

Summary

Since 1971, the world market has discounted the dollar in terms of gold to the tune of 96%.

Since 1971, a gallon of gas has increased about tenfold in terms of dollars, but costs around half as much priced in gold.

In 1971, 1,000 oz of gold could buy you an above average house. If you had buried those coins in the backyard and now had dug them up, they would buy you a $1,000,000 house.

By any measure, gold has been an immensely better store of value than the dollar over the past 37 years.
I know, I know. You can earn interest with dollars, but not with gold. Gold is not an investment. Well, your dollar savings would have to have earned 9+% APR every year for those 37 years in order to keep pace with gold's buying power.

Gold is a commodity that requires human labor to extract it from the Earth. A gallon of gas requires human labor to extract oil from the Earth and refine it to gasoline and then distribute it around the world.
The market values these commodities in part due to the cost of the human labor required to make the commodities available to the market.

It doesn't really matter that "oil is mostly useful" and "gold is mostly useless" in our technological and mobile civilization. Supply and demand work the same for both. The markets stubbornly refuse to devalue gold as much as the people who have monopoly control over gold's competition as a monetary unit would like it to. The market remembers that the value of gold lies principally in the fact that it is, and has been, the exchange commodity par excellence.

The market knows. The market does not take orders. Telling the market that gold is archaic and silly hasn't swayed its opinion. Telling the market that gold is worth $42.2222 per troy ounce is downright hilarious. Perhaps the Treasury would like to sell all its gold for $50 an ounce and "make a killing" on the deal? I'll buy some...

Paper and electronic dollars have, for all practical purposes, zero commodity value. They have government fiat value. They are "backed by the U.S. economy." OK, well the market has been discounting the dollar appropriately, and it appears the discounting will continue on at an accelerated pace.

Roosevelt declared that all the printed contracts that were circulating in the United States, payable in gold, were null and void. Then he devalued the dollar in relation to gold for the rest of the world. In 1934, gold was in fact international money. When you declare that your paper contracts that are redeemable in the world's acknowledged money commodity are now redeemable for less gold than they were the day before, you are defaulting on the contracts. Bretton Woods was a contractual agreement that Nixon broke in 1971.

When a debtor settles a debt for less then the contracted amount, then he has defaulted, or declared bankruptcy.

Period.

The world is still on a gold standard. The dollar, other fiat currencies, and gold are all competitive financial instruments.

Gold is going to win, and the market knows it. It is steadily reducing the values of all fiat currencies to zero against gold.

Gold has market value based on human labor required to mine the ore and bring the commodity to market, supply, and demand. The dollar has market value based on the United States declaring it to be legal tender for public and private debt, as well as other more coercive tactics such as convincing the world to use dollars to buy oil. I seem to remember Saddam changing his mind on that one just before the U.S. invaded Iraq and subsequently "corrected" the situation.

And all other fiat currencies are supported by the dollar as well as their respective governments' decrees, backed by force.

If and when the day arrives when demand for gold goes away, then it will be worthless, but I would bet against that. Imagine a Roman finding a gold coin on the road 2,000 years ago. Now imagine you find the same gold coin on the sidewalk 2,000 years later. Pretty much the same reaction, no? You could both go buy a snappy suit of clothes for the same coin. That's saying something, I think. There is no doubt in my mind that the demand for dollars will disappear before the demand for gold does. The dollar's long term fundamentals are pretty bad and getting much worse very quickly.

Bottom line, IMHO, is that it might could be prudent to convert at least some portion of one's assets into precious metals in order to have some catastrophe insurance, cause it looks like a catastrophe is happening right about now. Buckle up!

Postscript

To generalize the Petro scenario in one irresponsibly long sentence, if a market trades a set of products, and then one of the market participants creates a new product that is exchangeable for one of the existing market products that has already had its price discovered by that market a product the market knows and is familiar with a product with a long history on the market then if at a later date that new product can no longer be exchanged for the product it was advertised as being exchangeable for, and market participants have paid for this new product based on the price of the product it was supposed to be exchangeable with, then the participant who introduced the new product has defaulted on his promise to the market and has caused financial loss to those who have invested in that product instead of the product it was supposed to be exchangeable with.

After Bretton Woods the dollar was "as good as gold," nay better than gold. Nations could use the dollar as gold to be a reserve for their monetary system, and they could also earn interest holding dollars in the form of Treasuries. Gold bullion couldn't do that! If at any time a nation wished to convert their dollars back into gold, the U.S. promised they would do so at a $35 to 1 troy ounce exchange rate. Bait.
Then Nixon closed the gold window. And switch.